Solution manual cost accounting 8th by kinney chapter 06

How are equivalent units of production, unit costs, and inventory values determined using the weighted average WA method of process costing2. How are equivalent units of production, unit

Learning Objectives

After reading and studying Chapter 6, you should be able to answer the following questions:

1 Why are equivalent units of production used in process costing?

2 How are equivalent units of production, unit costs, and inventory values determined using the weighted average (WA) method of process costing?

3 How are equivalent units of production, unit costs, and inventory values determined using the first-in, first-out (FIFO) method of process costing?

4 How are transferred-in costs and units accounted for in a multidepartment production setting?

5 How are equivalent units of production, unit costs, and inventory values determined using the standard costing method of process costing?

6 Why would a company use a hybrid costing system?

7 (Appendix 1) What alternative methods can be used to calculate equivalent units of production?

8 (Appendix 2) How are normal and abnormal spoilage losses treated in an equivalent units of production (EUP) schedule?

PROCESS COSTING CHAPTER

6

Terminology Continuous loss: a loss that occurs fairly uniformly through the production process

Cost of production report: a process costing document that details all manufacturing quantities and

costs, shows the computation of cost per equivalent unit of production, and indicates the cost assigned to goods produced during the period

Discrete loss: a loss that is assumed to occur at a specific point and that is detectible only when a

quality check is performed

Equivalent units of production (EUP): approximations of the number of whole units of output that could

have been produced during a period from the actual resources expended during that period; used in process costing systems to assign costs to production

First-in, first-out (FIFO) method (of process costing): a method that separates beginning work in

process inventory and current period production and their costs so that a current period cost per unit can

be calculated

Hybrid costing system: a costing system that combines characteristics of both job order and process

costing systems

Method of neglect: a method whereby the costs of normal shrinkage and normal continuous losses in a

process costing environment are excluded from the equivalent units schedule thus resulting in a smaller number of equivalent units of production; dividing production costs by a smaller number of equivalent units raises the cost per equivalent unit, thus spreading the cost of lost units proportionately over the good units transferred and those remaining in work in process inventory

Total cost to account for: the sum of the balance in Work in Process Inventory at the beginning of the

period plus all current costs for direct material, direct labor, and overhead

Total units to account for: the total number of units (whole and partial) worked on in the department

during the current period; it is sum of the actual beginning inventory units and the units started during the current period

Units started and completed: the number of units completed during the period less the units in

beginning inventory

Weighted average (WA) method (of process costing): a method of cost assignment that computes a

single average cost per unit of the combined beginning work in process inventory and current period production

Lecture Outline

A Introduction

1 General

a This chapter covers process costing, one of the two prevalent product costing systems found

in practice In addition to the weighted average and first-in, first-out methods, the chapter describes standard cost process costing and hybrid systems

b Companies choose their product costing system (process or job order) based, in part, on the nature of the products manufactured and customers served

i Job order costing is appropriate for companies making products or providing services in

limited quantities that conform to customer specifications

ii Process costing is appropriate for companies that manufacture products in a continuous

flow process or in batches of output containing units that are all basically identical (e.g., Kellogg’s Rice Krispies)

c Both job order costing and process costing accumulate costs by cost component in each

production department However, the two systems assign costs to departmental output differently

i In job order costing, costs are assigned to specific jobs and then, if possible, to units contained within the job

ii Process costing uses an averaging technique to assign costs directly to units produced during the period

B Introduction to Process Costing

1 General

a Process costing is a method of accumulating and assigning costs to units of production in

companies that make large quantities of homogeneous products such as food products, bricks, gasoline, candles, and paper

b Cost assignment in any production environment is essentially an averaging process In a nutshell, the actual unit cost of a product is found by dividing a period’s departmental

production costs by the period’s departmental production quantity, the average being

expressed by the following formula:

Unit cost = Production Costs / Production Quantity

2 Production Costs: The Numerator

a The numerator in the average product cost fraction is the sum of the actual direct materials cost, actual direct labor cost, and actual or predetermined overhead cost for the period

b Cost accumulation in a process costing system differs from job order costing in two ways:

i the quantity of products for which costs are accumulated:

 in job order costing, production costs are accumulated for each job or batch where such jobs or batches usually consist of a small quantity of units;

 in process costing, production costs are accumulated for each department or process

by product and usually involves the production of a large quantity of units;

ii the cost object to which the costs are assigned:

 in job order costing the cost object is the job;

 in process costing, the costs assignable to each product type are designated and attached to the specific production runs; then the costs are assigned to the units worked on during the period

c Text Exhibit 6-1 presents the source documents used to make initial cost assignments to

production departments during the period Costs are then reassigned at the end of the period (usually monthly) from the production departments to the units produced

i As in job order costing, direct material and direct labor costs present few problems for cost accumulation and assignment in a process costing system but overhead costs must

be allocated to output unless such costs are relatively constant and production volume is relatively steady between periods

LO.1: Why are equivalent units of production used in process costing?

3 Production Quantity: The Denominator

a The denominator in the unit cost formula represents total departmental production for the period

b If all units were 100% complete at the end of the period, one would simply count the units to obtain the denominator

c However, usually partially completed units remain in a department at the end of the period These units become beginning inventory for the next accounting period This production

sequence is illustrated in text Exhibit 6-2

i A two-period production sequence means that some costs for the units in beginning inventory were incurred last period and additional costs for those units will be incurred in the current period

ii Likewise, some costs will be incurred this period on units in ending inventory and more costs will be incurred on those units during the following period

d Process costing assigns costs to both fully and partially completed units by mathematically converting partially completed units into equivalent whole units

4 Equivalent units of production (EUP) are an approximation of the number of whole units of

output that could have been produced during a period from the actual resources expended during that period

a The following example illustrates the computation of equivalent units of production when there is no beginning inventory:

A department worked on 220,000 units in November 200,000 units were completed and 20,000 units were 40% complete at the end of the period

EUP = 200,000 completed units + (20,000 x 40%) = 208,000

b Separate EUP calculations must be made for each cost component as illustrated in text

Exhibit 6-3

i Some direct material must be introduced at the start of a production process or there would be no need for labor or overhead to be incurred The beginning material is one hundred percent complete throughout the process regardless of the percentage of completion of labor and overhead

ii Additional materials may be added at any point during processing, or continuously during processing, or even at the end of processing

iii One percentage of completion estimate may be made and used for conversion costs (direct labor and overhead) if overhead is applied on a direct labor basis, or direct labor and overhead are added to the product at the same rate

 However, the increased use of multiple cost pools and/or activity-based costing concepts makes it less likely that the degrees of completion for direct labor and overhead will be equal Thus, separate EUP computations for direct labor and overhead will be increasingly common

C Weighted Average and First-in, First-out Process Costing Methods

1 General

a The weighted average method is a method of computing production quantity (the

denominator) in a process costing system that focuses on the total work done to date

i The weighted average method focuses on the units that are completed in the current

period and the units remaining in ending inventory

ii The weighted average method is not concerned with when the work on completed units

was performed (whether in the prior period or in the current period)

iii Thus, the weighted average method does not distinguish between units started last period but finished this period and those that were both started and finished this period

b The FIFO method is a method of computing production quantity (the denominator) in a

process costing system that computes an average cost per equivalent unit of production using only current period production and cost information

i The FIFO method separates beginning inventory and current period production and their costs so that a current period cost per unit can be calculated

ii The FIFO method more realistically reflects the way in which most goods actually flow through the production system

iii The FIFO method does not commingle units and costs of different periods, so that

equivalent units and costs of beginning inventory are withheld from the computation of

average current period cost The focus is specifically on the work performed during the

current period, and the EUP schedule shows only that work

c The only difference between the calculations under the two methods is that the work

performed in the prior period on beginning inventory is included in the current period using

WA but is not included in the current period EUP using FIFO

2 One purpose of any costing system is the determination of a product cost for use on financial statements

a Costs must be assigned to goods transferred from WIP to Finished Goods Inventory (or to another department)

b In addition, at the end of any period, a value must be assigned to goods still in WIP

3 General approach to process costing

a Text Exhibit 6-4 outlines the six general steps in a process costing system

i Step 1: Calculate the physical units to account for;

ii Step 2: Calculate the physical units accounted for (verify that step 1 equals step 2); iii Step 3: Calculate the equivalent units of production;

iv Step 4: Calculate the total cost to account for;

v Step 5: Calculate the cost per equivalent unit of production; and

vi Step 6: Assign the costs to inventory accounts (verify that the total costs transferred out plus the costs in ending inventory (step 6) equal the costs determined in step 4)

b The total cost to account for is the sum of the balance in WIP at the beginning of the period

plus all current period costs for direct material, direct labor, and overhead

c An example is used to demonstrate the steps involved in the computation of EUP and cost assignment for both the WA and FIFO methods

i Text Exhibit 6-5 presents information for the April 2010 production activity of a candle

maker

LO.2: How are equivalent units of production, unit costs, and inventory values determined using the weighted average method of process costing?

4 Weighted Average Method

a Step 1: Calculate the total physical units to account for

i The total units to account for are the sum of whole and partial units worked on in the

department during the current period It is equal to actual beginning inventory units plus actual units started

 There were 10,000 units in beginning work in process inventory and 401,400 candles were started during the current period, giving total units to account for of 411,400 candles

b Step 2: Calculate the physical units accounted for

i Units were either completed and transferred out or remain (partially completed) in ending WIP

 406,000 candles were completed and transferred out while 5,400 partially completed candles remain in ending inventory, resulting in total units accounted for of 411,400 candles

c Step 3: Calculate the Equivalent Units of Production (EUP) using the weighted average method

i The units started and completed equal the difference between the number of units

completed for the period and the units in beginning inventory; it can also be computed as the number of units started during the period minus the units in ending inventory

 406,000 candles were completed and transferred out less the 10,000 units in beginning inventory equals 396,000 candles started and completed

ii Text Exhibit 6-6 illustrates the concepts of total units to account for, total units accounted

for, and units started and completed during the period

iii Two sets of EUPs are computed: Direct materials and Conversion (Labor and overhead)

 All DM is added at the beginning of the production process Therefore, ending WIP inventory is 100% complete as to material

 Ending inventory is 80% complete as to labor and overhead Since the percentage completion for both of these costs is the same, only one EUP computation

(conversion costs) is necessary

iv WA EUP is computed as the units transferred out plus the equivalent units in ending inventory

 DM: The 10,000 beginning units + 396,000 units started and completed = 406,000 units transferred out The equivalent units in ending inventory = 5,400 (5,400 x 100%); Thus, DM EUP = 406,000 + 5,400 = 411,400 candles

 Conversion: The 10,000 beginning units + 396,000 units started and completed = 406,000 units transferred out The equivalent units in ending inventory = 4,320 units (5,400 x 80%) Thus, Conversion EUP = 406,000 + 4,320 = 410,320 candles

d Step 4: Calculate the total costs to account for

i The total costs to account for consist of the cost of beginning inventory ($37,402) plus current period costs for DM and Conversion ($1,150,140) = $1,187,542

ii The beginning inventory cost and the costs added must be segregated by cost

component:

 Beginning inventory: DM costs of $11,886 and conversion costs of $25,516 =

$37,402

 Costs added: DM costs of $642,240 and conversion costs of $507,900 = $1,150,140

e Step 5: Calculate the cost per equivalent unit of production

i The cost per equivalent unit of production is found by dividing the total costs to date by the EUP quantity for each cost category:

 DM costs to date (Beginning DM + DM added) / DM EUPs:

($11,886 + $642,240) / 411, 400 = $1.59

 Conversion costs (CC) to date (Beginning CC + CC added / CC EUPs:

($25,516 + $507,900) / 410,320 = $1.30

ii Thus, the total cost per equivalent whole unit is $2.89 ($1.59 + $1.30)

f Step 6: Assign costs to inventories

i The amount of cost transferred to the next department is found by multiplying the number

of units transferred by the total cost per equivalent unit: 406,000 units x $2.89 =

$1,173,340

ii The amount of costs assigned to ending WIP Inventory is found by summing the cost of each equivalent unit in ending inventory:

DM (Ending inventory EUP of 5,400 x $1.59) $ 8,586

CC (Ending inventory EUP of 4,320 x $1.30) 5,616

iii The total cost accounted for is the sum of the costs transferred out ($1,173,340) and the ending inventory cost ($14,202) = $1,187,542

g The six steps listed above may be combined into a cost of production report as illustrated in

text Exhibit 6-7

i A cost of production report is a process costing document that details all operating and

cost information, shows the computation of cost per equivalent unit, and indicates cost assignment to goods produced during the period

ii Note that the Cost of Production Report presented in the exhibit reflects the Weighted Average Method of computing EUPs

h T-Accounts are provided in the text for the WIP and Finished Goods inventories to illustrate the flow of costs (using WA) through the system

LO.3: How are equivalent units of production, unit costs, and inventory values determined using the first-in, first-out (FIFO) method of process costing?

5 FIFO Method

a Steps 1 and 2 are the same for FIFO as they are for the Weighted Average Method

b Step 3: Calculate the equivalent units of production using the FIFO Method

i Under the FIFO Method, the work performed last period is not commingled with work of

the current period

ii Only current period work is considered (i.e., the work performed during the current period

to complete the beginning inventory, the work performed during the current period on units started and completed, and the work performed during the current period on the ending inventory units)

 The work required to complete the beginning inventory equals the whole units in beginning inventory x (1-% of work done in the prior period)

 Since all DM were added at the beginning of the production process, no additional material is needed in April Since beginning WIP inventory was 40% complete as to conversion costs at the beginning of the period, the company needs to complete the remaining 60% of the conversion work in the current period (10,000 x 60% = 6,000 EUP)

iii Candles started and completed and ending inventory are the same as under the

Weighted Average Method

iv EUPs are computed as follows:

DM Conversion

Work done this period on beginning units 0 6,000

+ Work done this period on units started & completed 396,000 396,000

+ Work done this period on ending units 5,400 4,320

v A reconciliation schedule of FIFO EUPs to Weighted Average EUPs is provided in the text

c Step 4: Determine the total cost to account for ($1,187,542) This step is the same as under the Weighted Average Method

d Step 5: Calculate the cost per equivalent unit of production

i The cost per equivalent unit is found by dividing the DM current period cost by the DM current period work (i.e., the DM EUP) and by dividing the Conversion current period cost

by the Conversion current period work (i.e., the CC EUP):

 DM: $642,240 / 401,400 = $1.60

 Conversion: $507,900 / 406,320 = $1.25

 Thus, the cost of starting and completing a unit in April is $2.85 ($1.60 + $1.25)

e Step 6: Assign costs to inventories

i A two step computation is needed to determine the cost of goods transferred out under

the FIFO method

 Step a: Determine the total cost of the units started last period and finished this period (these are the units that were in beginning inventory on April 1):

Beginning inventory cost: $37,402 + Cost this period to complete beginning units: 7,500 $ 44,902

 Step b: Determine the cost of the units started and completed this period:

Units started and completed x Cost per EUP:

396,000 x $2.85 = $1,128,600

Total cost transferred out = $1,173,502

ii As under the weighted average method, the amount of costs assigned to ending WIP Inventory is found by summing the cost of each equivalent unit in ending inventory:

DM (Ending inventory EUP of 5,400 x $1.60) $ 8,640 Conversion (EI EUP of 4,320 x $1.25) 5,400 $ 14,040 iii The total cost accounted for is the sum of the costs transferred out and the ending

inventory cost: $1,173,502 + $14,040 = $1,187,542

f The six steps listed above may be combined into a cost of production report as illustrated in

text Exhibit 6-8

g Summary journal entries and T-Accounts for April are provided in text Exhibit 6-9

LO.4: How are transferred-in costs and units accounted for in a multidepartment production setting?

D Process Costing in a Multidepartment Setting

1 Goods are transferred from a predecessor department to a successor department

a For example, suppose a company has two departments, A and B When the goods are finished in Department A they are transferred to Department B Transferred Out costs of Department A become Transferred-in Costs of the Department B

b Therefore, Department B will have an additional cost category, Transferred-in Costs This category is analyzed in the same way as the other cost categories (DM and Conversion)