Abebe Manaye(አበበ ማናዬ): Cost Accounitng Chapter 3

Chapter 3: Product Costing Systems

Two costing systems are commonly used in manufacturing and in many service companies; these two systems are known as process costing and job-order costing.

A process costing is used in situations where the company produces many units of a single product for long periods at a time. In this system, the cost object is masses of identical or similar units of a product or service.

A job-order costing is used in situations where many different products are produced each period.

JOB ORDER COSTING SYSTEM

§ A job order cost system provides a separate record of the cost of each particular quantity of product that passes through the factory. The system accumulates costs for a particular batch of production, commonly referred as a Job. A job has a definite starting and completion time as would, for example, the production of 10 pieces of windows, or 50 coffee tables.

§ In job order costing system, costs are accumulated by job. For each job, the firm maintains a separate job cost sheet, which is a record on which manufacturing costs of the job are accumulated.

Job order costing for manufacturing firms:

An interrelationship exists between the physical flow of production, and the cost accounting cycle. The flow of costs parallels the flow of work in the production settings.

Work and cost flow in job order costing cycle

The physical flow of production is the sequence of operating activity that begins with the decision to order direct materials and ends with finished product being sold to customers. The intervening steps may vary from firm to firm, but they share a common thread. The following may show the steps of the physical flow of production.

Purchase requisition – For commonly used direct materials, organizations have a reorder level, which is the minimum amount of stock that can be on hand at any given time before another purchase is made to meet the lead time demand. The reason for maintaining such a minimum stock level is to hedge against the risk of stock shortages due to reasons like unexpected heavy usage, delays and other reason that results in stock out situations. When the stock level reaches such a point, the storeroom clerk fills a purchase requisition, a form requesting the purchase of the needed material. After the form is duly filled, it will be sent to the purchasing department.

A sample of purchase requisition form looks like the one as follows:

ALDER Furniture Factory Date January 5, 2004 Requisition no. 121
Purchase requisition form Prepared by:
Quantity	Description	Date needed
1,000.00 board ft	Lumber (eucalyptus)	January 15, 2004

5 gallons	Glue	January 15, 2004

50 boxes	Nails	January 15, 2004

F No journal entry is required when a purchase requisition is prepared.

Purchase order – the purchasing department following purchase requisitions from the storeroom clerk will prepare a purchase order. A purchase order is a document that authorizes the supplier to ship the specified merchandise ordered. A typical purchase order may contain the following:

A sample purchase order looks the following:

ALDER Furniture Factory Purchase order form Date January 6, 2004 Purchase No. 496
Vendor Gentle lumber processing Arat Kilo, Close to AAU, Science faculty
F.O.B point	Ship Via	Terms	Delivery date	Requisition no.
Factory site	Tana Transport PLC	2/10, n/30	Jan. 15, 2003	121
Item no.	Quantity	Description	Unit price	Total
1.	1,000 board ft.	Lumber (eucalyptus)	20	20,000.00

F No journal entry is required when a purchase order is filled.

Receiving report – when the ordered materials are received, the receiving department prepares a receiving report, which lists the description, and quantities of goods received. A copy of the document will be sent to the storeroom clerk along with the materials. The receiving report, together with the invoice of the supplier forms the basis for recording the purchase of the materials. The purchase of the lumber in the above example, for instance, would be as follows:

		Dr.	Cr.
January 15, 2003	Direct material Account payable	20,000.00	20,000.00

A sample receiving report is shown below.

ALDER Furniture Factory

Receiving report form

Received from:

Gentle lumber processing Arat Kilo

Close to AAU, Science faculty

Receiving report No. R 1345

Freight:

Pd Collect

Purchase order No. 496

Date received: February 15, 2003

Received by: Abera G.

Quantity

Description

Weight

Gross

Net

1,000 board ft.

Lumber (eucalyptus)

Production order – a manufacturer can produce in response to a customer order or just for stock. Whatsoever, when the decision to produce is made, productions order will be prepared and approved by the manager in charge.

A sample production order is presented here below:

ALDER Furniture Factory Production Order
Date: January 19, 2003 Job No. 365
Manufactured for: Stock
Date needed: March 20, 2003
Quantity	Model number	Description
150	F. 4152	Coffee table
Authorized by: Dereje Demissie

F No journal entries are required on the company’s books when the production order is issued.

Material requisition – to commence production, evidently the production department needs direct materials. The materials required for production are requested through a document called material requisition form. The material requisition form should contain specific description of the direct and indirect materials required for production.

A sample material requisition form is shown below:

Material requisition No. 906 Date: January 28, 2003 Job No. to be charged: 365
Quantity	Description	Unit cost	Total cost	Classification
500 board ft.	Lumber	20	10,000.00	Direct
1 box	Nail	22	220	Indirect
1 Gallon	Glue	30	30 10,252.00	Indirect
Direct materials -------10,000.00 Authorized signature Indirect materials ---------520.00

At the time the materials are issued from the storeroom, the following entry is made:

Jan. 28, 2003

Work in process

Manufacturing overhead

Raw materials

10,000.00

250.00

10,250.00

Direct materials that are sent for manufacturing process are no more direct materials since they are soon to be processed to become finished goods Thus, the cost is charged to work in process account.

Job Cost Sheet

Ø Right after the materials are received from store, a job cost sheet will be prepared. The job cost sheet is used to accumulate the manufacturing costs incurred in producing that particular job.

Ø The key source document in a job costing system is a job cost record, also called a job cost sheet, a document that records and accumulates all the costs assigned to a specific job. The job cost record is started as soon as work begins in a particular job.

Ø After being notified that the production order had been issued, the Accounting Department prepares a job cost sheet. A job cost sheet is a form prepared for each separate job that records the materials, labor, and overhead costs charged to the job.

Ø In addition to serving as a means for chagrining costs to jobs, the job cost sheet also serves as a key part of a firm’s accounting records. The job cost sheet form a subsidiary ledger to the Work in Process account. A separate cost sheet is maintained for each job. Thus, the value of work in process at any time can be found by adding the different job cost sheet.

The following is a sample job cost sheet:

Job Cost sheet
Job No. 365						Date started: Jan. 29, 2003 Date completed: March 20, 2003
Item 4152 – coffee tables For stock
Direct material				Direct labor				Manufacturing overhead
Date	Req. No.		Amount	Date	Hours		Amount	Date	DLH	Rate	Amount
Jan. 28, 2003	906		10,000
Cost summary
Cost Item						Amount
Total direct material
Total direct labor
Total manufacturing overhead applied
Shipping summary
Date		Number of units shipped				Cost balance

Job time ticket – the second cost category of manufacturing firms is the direct labor employed. A job time ticket is used to record how much time is spent on a particular job. When a particular job is started, the employee fills the time the job is started on the job time ticket, and he punch out the card and fills the time he stopped when he left the job. Suppose analysis of the job time ticket showed direct labor of 9,600.00 and indirect labor of 4,800.00, the journal entry to record the cost of direct and indirect labor looks like the following:

Jan. 28, 2003

Work in process

Manufacturing overhead

Wages payable

9,600.00

4,800.00

14,400.00

A sample of job time ticket is shown below

Job Time Ticket
Employee’s Name:		Date: March 5
Department: Sanding		Time started: 8:30 am Time completed: 11:30
Operation: Sanding		Job no. 365
Hours	Rate of pay	Direct labor	Comment
3 hrs.	8	24

Idle time may exist because of machine breakdown, or when there is material shortage or time lost while the employee shifts from one job to another. The cost of idle time should be absorbed by all units produced in the year instead of cost of a specified product. Thus, cost of idle time is debited to overhead.

Manufacturing overhead – costs other than direct material and direct labor that are necessary to transform the raw materials into finished goods are called manufacturing overhead.

Such Manufacturing costs are common costs – costs shared by more than one cost object- that should be apportioned among the cost objects sharing the cost.
However, the total overhead costs cannot be known exactly until the end of the year. Thus, organizations should wait up to the end of the year if they are to charge the actual amount.
Yet, many jobs are completed but the job cost sheet remains open waiting for the actual overhead cost. Thus, interim financial statements are impossible which in turn affect managerial decision purposes.
A predetermined overhead rate is determined to allocate such costs to individual jobs, which is found by dividing estimated overhead cost to the estimated amount of allocation base.
The allocation base is assumed to be a cost driver of manufacturing overhead costs.
In other words, there has to be a cause and effect relationship between the allocation base and manufacturing overhead costs. For instance, a labor intensive firm should use a labor oriented base, and a machine base should use a machine oriented base since most these overhead costs may respond to a change to the allocation base.

Costs include factory rent, electricity, and depreciation on machinery. Most of these costs are common to more than one batch of job and hence cannot be directly traced to a specific job.
Thus, such costs must be assigned to the different cost objects in some way. However, assigning MO to units of product is a difficult task; because of three reasons:

1. MO is an indirect cost, it is difficult to trace to a particular job.

2. MO consists of many different items ranging from the grease used in machines to the annual salary of production manager.

3. MO costs tend to remain relatively constant due to the presence of fixed costs.

Therefore, the only way to assign overhead costs to products is to use an allocation process. This allocation overhead cost is accomplished by selecting an allocation base that is common to all of the company’s products and services.
An allocation base is a measure such as direct labor hours (DLH) or machine hours (MH) that is used to assign overhead costs to products and services. The allocation base is used to compute the predetermined overhead rate:

Predetermined overhead rate = Estimated total manufacturing overhead cost

Estimated total units in the allocation base

Ø The predetermined overhead rate is based on estimated rather than an actual figure. This is because the predetermined overhead rate is computed before the period begins and is used to apply overhead cost to jobs throughout the period. The process of assigning overhead cost to jobs is called overhead application.

Overhead applied to a particular job = Predetermined * Amount of the allocation

overhead rate base incurred by the job

A predetermined overhead rate is calculated using the projected overhead cost and some activity base that has a cause and effect relationship with manufacturing overhead costs. For instance, assume that the projected overhead cost for the upcoming year is Birr 80,000.00, and the direct labor hour is estimated to be 4,000 hrs, the predetermined overhead rate can thus be calculated as follows:

Predetermined overhead cost = Estimated overhead cost

Estimated activity base (direct labor hr.)

POR = 80,000 = 20 per direct labor hour

4,000

If we assume that the direct labor hours spent on the job are 90, the manufacturing overhead applied will therefore be 90 X 20 =1800. The entry to record the manufacturing overhead applied is as follows:

March 18, 2003

Work in process

Manufacturing overhead applied

1,800.00

The manufacturing overhead applied is a contra account to the actual manufacturing cost.

Although actual costs are not assigned, they should be recorded as incurred. Suppose that factory rent, utilities, and other manufacturing costs totaled Birr 22,000.00. The following entry is required to record the actual manufacturing cost.

March 20, 2003

Manufacturing overhead

Various accounts

22,000.00

Finished goods inventory ledger card – when work in process is completed and transferred to the finished goods inventory warehouse, the following journal entry is required:

March 20, 2003

Finished goods

Work in process

21,400.00

Cost of goods sold – two records are maintained when sale is made under the perpetual inventory system: one for sales and the other for cost of goods sold. Assume that half of the coffee tables produced are sold for birr 180 each on with a 40% down payment. The entry to record the sales looks the following:

April 10, 2003

Cash

Account receivable

Sales

5,400.00

8,100.00

13,500.00

The total units produced are 150 as shown in the production order. Half of that amount is 75, and 75 units at 180 is equal to 13,500.00. When we come to the cost of goods sold, the total cost of goods produced is Birr 21,400.00. Thus, the unit cost of each coffee table is Birr 142.67. The cost of the 75 units that are sold is Birr 10,700.00.
The following entry is necessary to record the cost of goods sold.

April 10, 2003

Cost of goods sold

Finished goods

10,700.00

Actual Costing versus Normal costing

The use of an applied overhead instead of an actual overhead has the advantage of timeliness, and hence relevance for timely decision making. However, the amount may not be as accurate as the actual overhead cost. But the actual cost is known only at the end of the period, and thus product costing is impossible before the year ends. Actual costing thus makes product costing untimely, and this in turn affect decisions like product pricing, and controlling operations. Therefore, most firms use an applied overhead cost than actual cost for indirect manufacturing costs.

§ Normal costing is a costing system where the actual direct material and direct labor are added to the work in process inventory at the actual amount, and overhead costs are applied to the work in process inventory using a predetermined overhead rate. The term normal comes from the idea that the rate is normalized over a long period of time.

§ Actual costing is a costing system where direct material and direct labor costs are traced to the job at their actual amounts, and overhead costs are allocated using actual overhead. Since manufacturing overhead costs cannot be directly traced to each job in an economically feasible way, still the amount charged to each job is simply an allocated amount. The difference is simply the use of an actual overhead than an estimated overhead.

The table below shows summary of actual and normal costing

	Cost Assignment	Actual costing	Normal costing
Direct material	Tracing	Actual	Actual
Direct labor	Tracing	Actual	Actual
Manufacturing overhead	Allocation	Actual over head rate X actual cost driver used	Estimated overhead rate X actual amount of cost driver

Disposition of over and under applied overhead

Under normal costing, the actual amount of manufacturing overhead costs at the end of the period rarely matches with the applied manufacturing overhead costs during that same period. Often the applied amount may either be less or more than the actual amount.

§ If the amount of manufacturing overhead is less than the actual amount, the difference is said under-applied overhead or under absorbed overhead. When the reverse is true, the difference is said over-applied overhead or over absorbed overhead.

§ Under and over-applied overhead at the end of one fiscal year should not be carried to the upcoming periods; rather they should be disposed off in the year the difference occurs. The disposition of under and over applied overhead costs can take one of the following two ways.

Ø Closed out to Cost of Goods Sold.

Ø Allocated between Work in Process, Finished Goods, and Cost of Goods Sold in proportion to the overhead applied during the current period in the ending balances of these accounts.

Closed out to Cost of Goods Sold

Cost of Goods Sold xxx

Manufacturing Overhead xxx

(If the actual cost > overhead applied = Under-applied)

Manufacturing Overhead xxx

Cost of Goods Sold xxx

(If the actual cost < overhead applied = Over-applied

§ Suppose that the manufacturing overhead – control has a debit balance of Birr 607,500, and the manufacturing costs applied is Birr 540,000. The under applied manufacturing overhead cost can thus be disposed to cost of goods sold in the following manner:

	Debit	Credit
Cost of goods sold Manufacturing overhead applied Manufacturing overhead -control	67,500.00 540,000.00	607,500.00

	Debit	Credit
Cost of goods sold Manufacturing overhead	67,500.00	67,500

Ø The applied manufacturing overhead is a contra account to manufacturing overhead control, and thus, the normal balance for the applied manufacturing overhead is credit.

Ø At the end of the period both must be closed. The applied manufacturing overhead is debited and the manufacturing overhead is credited, and any difference is closed to cost of goods sold.

Allocated Between Accounts (Proration Approach)

Under and over applied overhead costs can also be disposed off by prorating to work in process, finished goods inventory and cost of goods sold. Assume the following information is pertaining to Awash Manufacturing Company:

	End of year balance before proration	Manufacturing overhead allocated component of year-end-balances (before proration)
Work in process	11,400.00	3,907.00
Finished good	18,600.00	7,814.00
Cost of goods sold	427,500.00	183,629.00
Total	457,500.00	195,350.00

Ø Further, assume that the manufacturing overhead control account shows a debit balance of Birr 192,650.00, which shows an over-applied balance of Birr 2,700.00. The over applied amount of manufacturing overhead will be prorated to work in process, finished good, and cost of goods sold.

o The proration base may be on the basis of the manufacturing overhead applied to the three accounts, or on the respective balance of the three accounts. Prorating on the basis of the manufacturing overhead applied is theoretical sound than using the year-end balance. The table below shows the proration process:

Account	Account balance	Manufacturing overhead applied (%)	Proration of the over allocated overhead	Account balance after proration
Work in process	11,400.00	3,907.00 = 2%	2% X 2,700.00=54	11,346.00
Finished good	18,600.00	7,814.00 = 4%	4% X 2,700.00=108	18,492.00
Cost of goods sold	427,500.00	183,629.00=94%	94% X 2,700=2,538.00	424,962.00
Total	457,500.00	195,350.00	2,700.00	454,800.00

The following journal entry is required to show the proration of the over allocated overhead.

	Debit	Credit
Manufacturing overhead applied Work in process Finished good Cost of goods sold Manufacturing overhead -control	195,350.00	54.00 108.00 2,538.00 192,650.00

	*Debit*	*Credit*
Manufacturing overhead Work in process Finished good Cost of goods sold	2700.00	54.00 108.00 2,538.00

§ The over-allocated amount is prorated and the balance of work in process, finished good, and cost of goods sold is reduced. The amount is reduced because the costs of the three accounts initially charged higher than the actual, and thus the balance must be reduced.

§ The over-allocated amount can be prorated on the basis of the year-end balance of the respective accounts as well. The following table shows the proration of the over allocated cost on the basis of the year-end balance of the three accounts.

Account	Account balance	Proration of the over allocated overhead	Account balance after proration
Work in process	11,400.00	11,400/457,500.00 = 2.5% 2.5% X 2,700.00 = 67.5	11,332.50
Finished good	18,600.00	18,600.00/457,500.00 = 4% 4% X 2,700.00 = 108	18,492.00
Cost of goods sold	427,500.00	427,500.00/457,500.00 = 93.5% 93.5% X 2,700.00 = 2,524.5	424,975.50
Total	457,500.00	2,700.00	454,800.00

The journal entry is the same except that the amount is different. The journal entry looks the following:

	Debit	Credit
Manufacturing overhead applied Work in process Finished good Cost of goods sold Manufacturing overhead -control	195,350.00	67.50 108.00 2,524.50 192,650.00

	Debit	Credit
Manufacturing overhead Work in process Finished good Cost of goods sold	2700.00	67.50 108.00 2,524.50

Process Costing

The process cost system accumulates costs without attempting to allocate them during the accounting period to specific units of goods being manufactured. At the end of the fiscal period, the average cost per unit is determined by dividing the total cost accumulated to the total number of units produced. Because of these techniques, process costing is often referred to as average costing. If the process costing system is used, the goods manufactured must be similar in nature so that an average cost will be meaningful. The process cost system is commonly used in such manufacturing operations as cement plants and flour mills, in which the production process is standardized and continuous and the product remains essentially the same from day-to-day.

In many types of business use process costing, manufacturing consists of a progressive series of distinct operations or processes. Usually each process is carried out in different department. A unit cost may be computed for each process or department. This departmental unit cost may be a useful tool in measuring and controlling efficiency. The total cost of production determined by adding up the departmental costs.

A process costing is most commonly used in industries that produce essentially homogeneous (i.e. uniform) products on a continuous basis.
Firms producing distinct and unique products use job order costing where as firms producing similar or identical units use process-costing system.
Process costing system accumulate costs by department for a period of time, just as a job order costing system accumulate costs by job, and the total cost then will be assigned to the units produced during that period.

Similarities between job-Order and Process Costing

The same basic purposes exist in both systems, which are to assign material, labor, and overhead cost to products and to provide a mechanism for computing unit costs.
Both systems maintain and use the same basic manufacturing accounts, including MO, Raw Materials, Work in Process, and Finished Goods.
The flow of costs through the manufacturing accounts is basically the same in both systems.

Differences between Job-Order and Process Costing

Job-Order Costing	Process Costing
1. Many different jobs are worked on during each period, with each job having different production requirements. 2. Costs are accumulated by identical job. 3. The job cost sheet is the key document controlling the accumulation of costs by a job. 4. Unit costs are computed by job on the job cost sheet.	1. A single product is produced either on a continuous basis for long periods of time. All units of product are identical. 2. Costs are accumulated by department. 3. The department production report is the key document showing the accumulation and disposition of costs by a department. 4. Unit costs are computed by department on the department production report.

In manufacturing process costing setting, each unit is assumed to receive the same amount of direct materials cost, direct manufacturing labor costs, and indirect manufacturing costs. Units are computed by dividing total costs by the number of units.
The principal difference between process costing and job costing is the extent of averaging used to compute unit costs of products or services. In job-costing system, individual jobs use different quantities of production resources. Thus, it would be incorrect to cost each job at the same average production cost.
In contrast, when identical or similar units of products or services are mass produced, and not processed as individual jobs, process costing averages production costs over all units produced.

The Flow of Costs in Process-Costing System with Sequential Production Departments

As direct materials and direct labor are used in production department A, these costs are added to the Work-in-Process inventory account for Department A. Overhead is applied using predetermined overhead rate. The POR is determined in the same way in job order and process costing.

Work-in Process: Production Department A xxx

Raw Materials xxx

Wage Payable xxx

Manufacturing overhead applied xxx

When production department A completes its work on some units of product, these units of product are transferred to production department B. The costs assigned to these goods are transferred from the Work-in Process Inventory account for department A to work-in Process inventory account in department B, the costs assigned to those partially completed products are called transferred-in costs[1].

Work-in Process: Production Department B xxx

Work-in Process: Production Department A xxx

Direct material and direct labor are used in production department B, and manufacturing overhead is applied using POR.

Work-in Process: Production Department B xxx

Raw Materials xxx

Wages Payable xxx

Manufacturing overhead applied xxx

Goods are completed in production department B and transferred to the finished goods warehouse.

Finished-Goods xxx

Work-in Process: Production Department B xxx

Goods are sold

Cost of Goods Sold xxx

Finished-Goods ` xxx

Cost Accumulation Methods in Process Costing System

When a firm produces identical lots of goods repetitively, maintaining a separate job cost sheet would be unnecessarily expensive. The aggregate cost and the unit cost can be computed without a job cost sheet, thus saving the costs associated with producing such records.
Costs accumulate by department over a certain period and the unit cost can be found by dividing the total cost to the units produced during that period. Process costing system fit among others to, paint manufacturers, oil refineries, sugar refineries, and salt producers.
In process costing system, manufacturing costs, direct material, direct labor, and manufacturing overhead costs are accumulated in the same way as job order costing system. However, the costs are accumulated by department over some period of time than by individual jobs.
The time period over which the cost is to be accumulated depends on the information needs of the company. It can be a week, two weeks, but no longer than a month most often. Cost accumulation is much simpler for a process costing system than for a job order cost system.

Illustrating Process Costing

Assumptions: ABC Manufacturing Company manufactures thousands of Products A. These components are assembled in the Assembly Department, upon completion the units are completely transferred to the Testing Department. The process-costing system for Product A has a single direct cost category (direct materials) and a single indirect-cost category (conversion costs). Direct materials are added at the beginning of the process in Assembly. Conversion costs are added evenly during Assembly.

Case 1: Process costing with zero beginning and zero ending work in process inventory that is all units are started and fully completed by the end of the accounting period.

Data for the Assembly Department for January 2012

Solution:

Case 2: Process Costing with zero beginning but some ending work in process inventory

Data for the Assembly Department for February 2012:

Physical Units for February 2012

Work in Process, beginning inventory (February 1) 0 units

Started during February 400 units

Completed and transferred out during February 175 units

Work in Process, ending inventory (February 28) 225 units

Total Costs for February 2012

Direct materials costs added during February Br.32,000

Conversion costs added during February 18,600

Total Assembly Department costs added during February 50,600

OR Illustration of Case 2 in other method:

In addition, the Assembly Department estimates that the partially assembled units are on averages 60% complete as to conversion costs.

How should the co. calculate the cost of fully assembled units in February 2001 and the cost of partially assembled units still in process at the end of February 2001?

Steps:

F Summarize the flow of physical units of output

F Compute output in terms of equivalent units

F Compute equivalent unit costs

F Summarize total costs to account for

F Assign total costs to unit’s completed and to units in ending work in process

Equivalent Units: A key Concept

Material, labor and overhead costs are incurred at different rates in production process. Direct material usually placed in production at one or more discreet points in the process. In contrast, direct labor and manufacturing overhead, called conversion costs, and usually are incurred continuously 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.

Example: Suppose there are 1000 physical units in process at the end of an accounting period. Each of the physical units is 75% complete with respect to conversion. How much conversion activity has been applied to these partially completed units?

Conversion activity occurs uniformly throughout the production process. Therefore, the amount of conversion activity required to do 75% of the conversion on 1000 units is equivalent to the amount of the conversion on 750 units. The number is computed as follows:

1000 partially completed physical units in process * 75% complete with respect to Conversion = 750

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. The 1000 physical units in process represent 750 equivalent units of conversion activity.

The term equivalent unit is also used to measure the amount of direct materials represented by the partially completed goods. Since direct materials are incorporated at the beginning of the production process, the 1000 physical units represent 1000 equivalent units of direct material ( 1000 physical units * 100% complete with respect to direct materials).

Physical units and Equivalent units (Step 1&2)

Equivalent units is a derived amount of output units that takes the quantity of each input (factor of production) in units completed or in work in process, and converts it into the amount of completed output units that could be made with that quantity of input.

Steps 1 and 2: Summarize Output in Physical Units and Compute Output in Equivalent Units for Assembly Department

Calculation of Product Costs (Steps 3, 4, and 5) Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed and to Units in Ending Work in Process for Assembly Department

Journal Entries

Journal entries in process-costing systems are similar to the entries made in job-costing systems with respect to direct materials and conversion costs. The main difference is that, in process costing, there is one Work in Process account for each process. In our example, there are accounts for Work in Process—Assembly and Work in Process—Testing. The manufacturer purchases direct materials as needed. These materials are delivered directly to the assembly department.

Case 3: Process costing with some beginning and some ending work in process inventory.

Data for the Assembly Department for March 2012

Physical Units for March 2012

Work in Process, beginning inventory (March 1) 225 units

Direct Materials (100% complete)

Conversion costs (60% complete)

Started during March 275 units

Completed and transferred out during March 400 units

Work in Process, ending inventory (March 31) 100 units

Direct Materials (100% complete)

Conversion costs (50% complete)

Total Costs for March 2012

Work in process, beginning inventory

Direct materials (225 equivalent units * Br. 80/unit) Br. 18,000

Conversion costs (135 equivalent units * Br. 60/unit) 8,100 Br. 26,100

Direct materials costs added during March 19,800

Conversion costs added during March 16,380

Total costs to account for Br. 62,280

Weighted-Average process costing method

> This method calculates the equivalent unit cost of the work done to date (regardless of the period in which it was done) and assigns this cost to equivalent units completed and transferred out of the process and to equivalent units in ending work in process inventory.

> The weighted average cost is the total of all costs entering in the work in process account (regardless of whether it is from the beginning work in process or from work started during the period) divided by total equivalent units of work done to date.

Physical units and Equivalent units (Step 1 & 2)

Steps 1 and 2: Summarize Output in Physical Units and Compute Output in Equivalent Units Using Weighted-Average Method of Process Costing for Assembly Department

	*(Step 1)*	*(Step 3)*
		*Equivalent Units*
*Flow of Production*	*Physical Units*	*Direct Materials*	*Conversion Costs*
Work in process, beginning	225
Started during current period	275
To account for	500
Completed and transferred out during current period	400	400	400
Work in process, ending ^a	100
(100 x 100%; 100 x 50%)		100	50
Accounted for
Equivalent units of work done to date		500	450

^aDegree of completion in this department; 100%; conversion costs, 50%

Calculation of Product Costs (Steps 3, 4, and 5)

Steps 3, 4, and 5: Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed and to Units in Ending Work in Process Using Weighted-Average Method of Process Costing for Assembly Department

		Total Production Costs	Direct Materials	Conversion Costs
(Step 3)	Work in process, beginning	$26,100	$18,000	$8,100
	Costs added in current period	36,180	19,800	16,380
	Total costs to account for	$62,280	$37,800	$24,480

(Step 4)	Cost incurred to date		$37,800	$24,480
	Divided by equivalent units of work done to date		+ 500	+ 450
	Cost per equivalent unit of work done to date		$75.60	$54.40

(Step 5)	Assignment to costs:
	Completed and transferred out (400 units)	$52,000	(400^ax$75.60)	(400^ax$54.40)
	Work in process, ending (100 units)	10,280	(100^bx57.60)	(50^bx54.40)
	Total costs accounted for	$62,280	$37,800	#24,480

^a Equivalent units completed and transferred out
^b Equivalent units in ending work in process

Journal Entries

First-in, First-out Method

> The FIFO process costing method assigns the cost of the previous period’s equivalent units in beginning work-in process inventory to the first units completed and transferred out of the process, and assigns the cost of equivalent units worked on during the current period first to complete beginning inventory, then to start and complete new units in ending work in process inventory.

> This method assigns that the earliest equivalent units in the work in process-Assembly account are completed first.

> A distinct feature of the FIFO process-costing method is that work done on beginning inventory before the current period is kept separate from work done in the current period.

> Costs incurred in the current period and units produced in the current period are used to calculate costs per equivalent unit of work done in the current period.

> In contrast equivalent unit and cost per equivalent unit calculations in the weighted average method merge the units and costs in beginning inventory with units and costs of work done in the current period.

Physical units and Equivalent units (Step 1 & 2): Summarize Output in Physical Units and Compute Output in Equivalent Units Using FIFO Method of Process Costing for Assembly Department

	*(Step 1)*	*(Step 3)*
		*Equivalent Units*
*Flow of Production*	*Physical Units*	*Direct Materials*	*Conversion Costs*
Work in process, beginning	225	(Work done before current period)
Started during current period	275
To account for	500
Completed and transferred out during current period:
From beginning work in process ^a	225
[225 x (100% - 100%); 225 x (100% - 60$]		0	90
Started and completed ^b
(175 x 100%; 175 x 100%)		175	175
Work in process, ending ^c	100
(100 x 100%; 100 x 50%)	___	100	50
Accounted for	500	___	___
Equivalent units of work done in current period		275	315

a Degree of completion in this department; direct materials, 100%; conversion costs, 60%
^b 400 physical units completed and transferred out minus 225 physical units completed and transferred out form beginning work in process inventory
^c Degree of completion in this department: direct materials, 100%; conversion costs, 50%

Calculation of Product Costs (Steps 3, 4, and 5): Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed and to Units in Ending Work in Process Using FIFO Method of Process Costing for Assembly Department

		Total Production Costs	Direct Materials	Conversion Costs
(Step 3)	Work in process, beginning	$26,100	$18,000	$8,100
	Costs added in current period	36,180	19,800	16,380
	Total costs to account for	$62,280	$37,800	$24,480

(Step 4)	Cost incurred to date		$19,800	$24,480
	Divided by equivalent units of work done to date		+ 275	+ 315
	Cost per equivalent unit of work done to date		$ 72	$ 52

(Step 5)	Assignment to costs:
	Completed and transferred out (400 units)
	Work in process, beginning (225 units)	$26,100	$18,000	$8,100
	Costs added to beg. work in process in current period	4,680	(0^ax$73)	(90^ax$52)
	Total from beginning inventory	30,780
	Started and completed (175 units)	21,700	(175^bx$72)	(175^bx$52)
	Total costs of units completed & transferred out	52,480
	Work in process, ending (100 units)	9,800	(100^cx$72)	(50^cx$52)
	Total costs accounted for	$62,280	$37,800	$24,480

^a Equivalent units used to complete beginning work in process
^b Equivalent units started and completed
^c Equivalent units in ending work in process

Journal Entry:

Work in Process- Testing 52,480

Work in Process- Assembly 52,480

(To record cost of goods completed and transferred from Assembly to Testing Department)

Important points to note:

Ø The first physical units assumed to be completed and transferred out during the period are the 225 units from the beginning work-in process inventory.

Ø Of the 275 physical units started, 175 are assumed to be completed. 400 physical units were completed during March, the FIFO method assumes that the first 225 of these units must have been started and completed during March.

Ø Ending work-in process inventory consists of 100 physical units-the 275 physical units started minus the 175 of these physical units completed.

Ø Note that the physical units “to account for” equal the physical units “accounted for” (500 units)

Ø The equivalent unit calculated for each cost category focus on the equivalent units of work done in the current period only. Under the FIFO method, the work done in the current period is assumed to first complete the 225 units in beginning work in process. The equivalent unit’s works done in March on the beginning work-in process inventory are computed by multiplying the 225 physical units by the percentage of work remaining to be done to complete these units: 0% for direct materials, and 40% for conversion costs.

Transferred-in Costs in Process Costing

Many process-costing systems have two or more departments or processes in the production cycle. As units move from department to department, the related costs are also transferred by monthly journal entries.

Ø Transferred-in costs also called previous department costs are the costs incurred in a previous department that are carried forward as the product’s cost when it moves to a subsequent process in the production cycle. That is as the units move from one department to the next, their costs are transferred with them.

Ø Transferred in costs are treated as if they are a separate type of direct material added at the beginning of the process. In other words, when successive departments are involved, transferred units from one department become all or a part of the direct materials of the next department; however they are called transferred-in costs, not direct material costs.

The following diagram represents these facts:

Example: In our example as the assemble process is completed the department transfers the units to its Testing Department. Here the units receive additional direct materials, such as packing materials for shipment, at the end of the process. Conversion costs are added evenly during the Testing Department’s process. As units are completed in Testing, they are immediately transferred to Finished Goods.

Data for the Testing Department for the month of March 2012 are:

Physical Units for March 2001

Work in Process, beginning inventory (March 1) 240 units

Transferred-in costs (100% complete)

Direct Materials (0% complete)

Conversion costs (62.5% complete)

Transferred in during March 400 units

Completed during March 440 units

Work in Process, ending inventory (March 31) 200 units

Transferred-in costs (100% complete)

Direct Materials (0% complete)

Conversion costs (80% complete)

Costs of Testing Department for March 2012

Work in process, beginning inventory

Transferred-in costs (240 equivalent units*140/ equ. Un) Br. 33,600

Direct materials 0

Conversion costs (150 equivalent units * Br.120/unit) 18,000 Br. 51,600

Transferred-in costs during March

Weighted-average 52,000

FIFO 52,480

Direct materials costs added during March 13,200

Conversion costs added during March 48,600

A. Transferred-in costs and the Weighted-Average Method

		Equivalent Units
*Flow of Production*	*Physical Units*	*Transferred in costs*	DM	CC
Work in process, beginning Transferred in during current period To account for Completed and transferred out during current period Work in process, ending 200100%; 2000%; 200*80% Accounted for Work done to date	240 400 640 440 200 500	440 200 640	440 0 440	440 160 600

	*Total Production Costs*	*Transferred in costs*	*DMs*	*CCs*
(Step 3) Work in process, beginning Costs added in the current period Costs incurred to date divided by Equivalent units of work done to date Cost per equivalent unit of work done (Step 4) Total costs to account for (Step 5) Assignment of Costs Completed and transferred out (440 units) Work in process, ending (200 units) Transferred-in costs Direct Materials Conversion costs Total work in process Total costs accounted for	Br.51,600 113,800 Br.165,400 120,890 26,750 0 17,760 44,510 Br. 165,400	Br.33,600 52,000 Br.85,600/ 640 Br.133.75 (440133.75) 200133.75	Br.0 13,200 Br.13,20/ 440 Br.30 (44030) 030	Br.18,000 48,600 Br 66,600/ 600 Br.111 (440111) 160111

To record cost of goods completed and transferred from Testing to finished goods.

Finished Goods Control 120,890

Work-in Process: Testing 120,890

B. Transferred-in costs and the FIFO Method

		Equivalent Units
*Flow of Production*	*Physical Units*	*Transferred-in costs*	*Direct Materials*	*Conversion costs*
Work in process, beginning Transferred-in current period To account for Completed and transferred out during current period From beginning work in process 2400%; 240(100%-0%); 200* (100%-62.5%) Started and Completed 200100%; for the three Work in process, ending 200100%; 2000%;20080% Accounted for work done in current period	240 400 640 240 200 200 640	0 200 200 400	240 200 0 440	90 200 160 450

	*Total Production Costs*	*Transferred-in cost*	*DMs*	*CCs*
(Step 3)Work in process, beginning Costs added current period Divided by equivalent units of work done in current period Costs per equivalent unit of work done in the current period (Step 4) Total costs to account for (Step 5) Assignment of Costs Completed and transferred out (440 units Work in process, beginning (240 units) Transferred-in costs added in current Direct Materials added in current Conversion costs added in current Total from beginning inventory Started and completed (200 units) Total costs of units completed & transferred Work in process, ending (200 units) Transferred-in costs Direct Materials Conversion costs Total work in process, ending Total costs accounted for	Br.51,600 114,280 Br.165,880 Br.51,600 0 7,200 9,720 68,520 53,840 122,360 26,240 0 17,280 43,520 Br. 165,880	52,480/ 400 Br. 131.20 0131.20 200131.20 200*131.20	13,200/ 440 Br. 30 24030 20030 0*30	48,600/ 450 Br. 108 90108 200108 160*108

To record cost of goods completed and transferred from Testing to finished goods.

Finished Goods Control 122,360

Work-in process: Testing 122,360

[1] Transferred-in costs are assigned to partially completed products that are transferred into one production department from a prior department.

Cost Accounitng Chapter 3

Actual Costing versus Normal costing

Disposition of over and under applied overhead

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