Principles of financial accounting 12e by needles crosson chapter 19

 In the first-in, first-out FIFO costing method , the cost flow follows the logical physical flow of production—that is, the costs assigned to the first materials processed are the firs

Concepts Underlying the Process

Costing System

the costs of direct materials, direct labor,

and overhead for each process, department,

or work cell and then assigns those costs to the products produced during a particular

period.

– Such a system is used for cost measurement by companies that make large amounts of similar products or liquid products or that have

continuous production runs of identical products.

– In this system, costs are measured and

recognized by production processes, not by jobs.

Patterns of Product Flows and

Cost Flow Methods

 In a process costing environment, products

flow through several processes, departments,

or work cells and may undergo many different operations.

– Take for example the simple linear production flow

of how milk is produced in a series of three processing steps, or departments.

 Each department has its own Work in Process Inventory account to accumulate the direct materials, direct labor, and overhead costs associated with it.

 The product unit cost of a bottle of milk is the sum of the cost elements in all three departments divided by the number of bottles of milk produced.

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Patterns of Product Flows and

Cost Flow Methods

 To measure and recognize product costs using process

costing requires the preparation of a process cost

product-related costs flow through the production process.

– Managers assign these costs to the units that have been

transferred out of the process and to the units that are still a part

of the work in process, using a cost allocation method.

 In the first-in, first-out (FIFO) costing method , the cost flow follows the logical physical flow of production—that is, the costs assigned to the first materials processed are the first costs transferred out when those materials flow to the next process, department, or work cell

 The average costing method assigns an average cost to all products made during a period This method uses total cost averages and does not try to match cost flow with the physical flow of

production.

Cost Flows Through the Work in Process

Inventory Accounts

 A process costing system has a separate Work in Process Inventory account for

each process, department, or work cell.

– As products move from one process,

department, or work cell to the next, the costs of the direct materials, direct labor, and overhead associated with them flow to the

next Work in Process inventory account.

– Once the products are completed, packaged, and ready for sale, their costs are transferred

to the Finished Goods Inventory account

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Computing Equivalent Production

 A process costing system does not

associate costs with particular job orders Instead, it assigns the costs incurred in a process, department, or work cell to the units in production during a period by

computing an average cost per unit of

effort

– Unit cost for the period is computed as follows: (Direct Materials + Direct Labor + Overhead) ÷ Number of Units = Unit Cost

Computing Equivalent Production

– Equivalent production (or equivalent units) applies a percentage-of-completion factor to partially completed units to calculate the equivalent number of whole units produced during a period for each type of input (direct materials, direct labor, and overhead).

 The number of equivalent units produced is (1) the sum of total units started and completed during the period and (2) an

amount representing the work done on partially completed products in both the beginning and ending work in process inventories.

 The costs of direct labor and overhead are often incurred

uniformly throughout the production process, so it is convenient

to combine them when calculating equivalent units These combined costs are called conversion costs (or processing

costs).

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Accounting for Units

 Managers must account for the physical flow of

products through their areas (Step 1) before they can compute equivalent production for the accounting

period (Step 2)

– Assume the following for Milk Products in February:

 The beginning work in process inventory consists of 6,200 partially completed units (60 percent processed in the previous period).

 During the period, the 6,200 units in beginning inventory were completed, and 57,500 units were started into

production.

 Of the 57,500 units started during the period, 52,500 units were completed The other 5,000 units remain in work in process inventory and are 45 percent complete.

Step 1: Account for Physical Units

 In Step 1, Milk Product’s department manager

computes the total units to be accounted for by adding the 6,200 units in beginning inventory to the 57,500 units started into production during this period.

 Step 1 continues accounting for physical units The

6,200 units in beginning inventory that were

completed during the period, the 52,500 units that

were started and finished in the period, and the 5,000 units remaining in the department at the end of the

period are summed, and the total is listed as “units

accounted for.” (Note that “units accounted for” must equal the “units to be accounted for” in Step 1.)

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Step 2: Account for Equivalent Units

(slide 1 of 2)

 Beginning Inventory

– Because all direct materials are added at the beginning of the production process, the 6,200 partially completed units that began February as work in process were already 100 percent complete in regard to direct materials

– They were 60 percent complete in regard to conversion costs

on February 1 The remaining 40 percent of their conversion costs were incurred during the month Thus, the current

equivalent production for their conversion costs is 2,480 (6,200 units X 40%).

 Units Started and Completed During the Period

– All the costs of the 52,500 units started and completed during February were incurred during this period Thus, the full

amount of 52,500 is entered as equivalent units for both direct materials costs and conversion costs.

Step 2: Account for Equivalent Units

(slide 2 of 2)

 Ending Inventory

– Because the materials for the 5,000 drinks still in process at the end of February were added when the drinks went into production during the month, the full amount of 5,000 is entered as the equivalent units for direct materials costs – However, these drinks are only 45 percent complete in

terms of conversion costs Thus, the equivalent production for their conversion costs is 2,250 (5,000 units X 45%).

Step 3: Account for Costs

in the Total Costs column.

Step 4: Compute Cost per Equivalent Unit

equivalent unit for direct materials and for conversion costs.

– Note that the equivalent units are taken

from Step 2 Prior period costs attached to units in beginning inventory are not

included in these computations because the FIFO costing method uses a separate costing analysis for each accounting period.

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Step 5: Assign Costs to Cost of Goods

Manufactured and Ending Inventory (slide 1 of 2)

 Cost of Goods Manufactured and Transferred Out

– Step 5 shows that the costs transferred out to the Finished Goods Inventory account include the $41,540 in direct materials and conversion costs for completing the 6,200 units in beginning inventory.

– Step 2 shows that 2,480 equivalent units of conversion costs were required to complete these 6,200 units Because the equivalent unit conversion cost for February is $5.60, the cost to complete the units carried over from January is $13,888 (2,480 units X $5.60) – Each of the 52,500 units started and completed in February cost

$8.90 to produce Thus, 52,500 units X $8.90 = $467,250.

– The cost assigned to the work completed during the period and transferred to Finished Goods is $522,678 ($41,540 + $13,888 +

$467,250).

Step 5: Assign Costs to Cost of Goods

Manufactured and Ending Inventory (slide 2 of 2)

– All costs remaining in Work in Process

Inventory after the cost of goods manufactured has been transferred out represent the cost of the drinks still in production at the end of February The balance

in the ending Work in Process Inventory is computed as follows:

(5,000 units x $3.30 per unit) + (2,250 x $5.60 per unit) =

$29,100

must always

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be the same number If they are not, look for omission of any costs, calculation errors, or

rounding differences.

Process Costing for Two or More

Production Departments

 A company that has more than one production

process or department must have a Work in

Process Inventory account for each process or

department.

– When products flow from the first department to the

second department, their costs flow from the first department’s Work in Process Inventory account to the second department’s Work in Process Inventory account – The costs transferred into the second department’s Work

in Process Inventory account are treated in the same way

as the cost of direct materials added at the beginning of the production process.

– At the end of the period, a separate process cost report is prepared for each department.

Preparing a Process Cost Report Using the

Average Costing Method

 When a process cost report uses the average costing method cost flows do not follow the

logical physical flow of production as they do with the FIFO method.

 Instead, the costs in beginning inventory are combined with current period costs to

compute an average product unit cost.

 Preparing a process cost report using the

average costing method includes the same

five steps as using the FIFO method, but the procedures for completing the steps differ.

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Step 1: Account for Physical Units

 Step 1 of a process cost report accounts for the physical units in a production process,

department, or work cell during a period.

 Units to be accounted for equals the physical units in beginning inventory plus the physical units started during the period.

 In Step 1, Milk Products’ department manager computes the total units to be accounted for

as follows:

6,200 units + 57,500 units = 63,700 units

Step 2: Account for Equivalent Units

(slide 1 of 2)

 Units Completed and Transferred Out

– The average costing method treats both the direct materials costs and the conversion costs of the 58,700 units completed

in February (6,200 units from beginning inventory + 52,500 started this period) as if they were incurred in the current period Thus, the full amount of 58,700 is entered as the equivalent units for these costs.

 Ending Inventory

– Because all direct materials are added at the beginning of the production process, the full amount of 5,000 is entered as the equivalent units for direct materials costs

– Because the 5,000 units in ending inventory are only 45

percent complete in terms of conversion costs, the amount of equivalent units is computed as follows: 5,000 units x 45% = 2,250 units

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Step 2: Account for Equivalent Units

– Milk Products accounted for 63,700 physical units Equivalent units for direct materials costs totaled 63,700, and equivalent units for conversion cots totaled 60,950.

Step 3: Account for Costs

conversion costs for beginning

inventory and the current period are

accumulated in the Total Costs column.

$209,900 in direct materials costs and

$341,878 in conversion costs.

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Step 4: Compute Cost per Equivalent Unit

 Step 4 computes the cost per equivalent.

– Note that the cost per equivalent unit for

both direct materials and conversion costs has been rounded to the nearest cent.

– Note also that the average costing and FIFO costing methods use different numerators and denominators in Step 4 Average costing

divides total cost by total equivalent units, whereas FIFO divides current costs by

current equivalent units.

Step 5: Assign Costs to Cost of Goods

Manufactured and Ending Inventory (slide 1 of 2)

 Cost of Goods Manufactured and Transferred Out

– The costs of the units completed and transferred out are assigned by multiplying the equivalent units for direct materials and conversion costs (accounted for

in Step 2) by their respective cost per equivalent unit (computed in Step 4) and then totaling these assigned values.

– Because the costs per equivalent unit were rounded in Step 4, a rounding difference of $362 has been

deducted from the total cost The $522,655 of transferred costs will go to the Finished Goods Inventory account, since the goods are ready for sale

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Step 5: Assign Costs to Cost of Goods

Manufactured and Ending Inventory (slide 2 of 2)

 Ending Inventory

– The costs of the units in ending work in

process inventory are assigned in the same way as the costs of cost of goods

manufactured and transferred out Thus, the total of costs assigned to ending inventory is computed as follows:

(5,000 x $3.30) + (2,250 x $5.61) = $29,123

- The $29,123 (rounded) will appear as the

ending balance in the Work in Process Inventory account.

The Management Process and the

Process Costing System

costing throughout the management