Mastering Product Costing and Process Design

1. May 14-15 Systems Design: Process Costing

2. May 14, 2009 • System Design – Process Costing • Review of Process Costing versus Job-Order Costing • When should Process Costing be Used? • How is it Used? • Journal entries • Calculating balances by the Weighted Average Cost method

3. Product Costing • Product Costing is the mapping and allocating of costs to a specific product • Its purpose is to provide executives with critical information including: • How to minimize costs • How to price a product competitively and profitably • There are two main methodologies of Product Costing • 1. Job-Order Costing – each job is different • 2. Process Costing – many of the same products

4. Job Order Costing • Job-Order Costing is the costing methodology applied in companies in the following circumstances: • Produce many different products or packages • Manufacture to order so each job is different • Examples would be: • SNC (engineering and construction) • Airbus (aircraft) • Other? • In these cases, a company needs to know, often on an order by order basis, what are the costs associated with fulfilling the order • Cost records for each job will be required to support decision making and billing of the customer

5. Process Costing • Process Costing is the costing methodology applied in companies in the following circumstances: • Produce many units of a single product • Each unit is substantially similar to other units • Examples would be: • Lenovo (PC manufacturing) • Frito lay (Snacks and beverages) • Others? • That each of these products are substantially the same, managers are able to apply the same average cost to each unit • Cost records for each job will be required to support decision making and billing of the customer

6. Similarities & Differences Between Job-Order and Process Costing • Similarities • Both are Product Costing systems assigning material, labour and overhead to products • Both systems use the same manufacturing accounts • The flow of costs are very similar in both systems • Differences • Process Costing is used for single products which run continuously (versus differing products/packages) • Process Costing tracks cost by department (versus by job) • Tracks unit cost by department (versus by job sheet)

7. Flow of Materials, Labor and Overhead Costs Costs are traced and applied to departments in a process cost system. Direct Materials FinishedGoods Processing Department Direct Labor ManufacturingOverhead Cost of GoodsSold

8. Processing Departments • The same three inputs go into Work in Process as in Job-Order Costing • In Process Costing, Processing Departments must be identified • A Processing department is any department in which the activities and output are uniform: • Assembly Department • Testing Department • Others? • Inventories get transferred from one department through to the other • Costs are accumulated in each department and average unit costs are used

9. Process Cost Flows & Journal Entries • Journal entry examples:

10. Equivalent Units of Production • Usually, there will be some Work in Process Inventory in a department at the beginning of the period • Each unit or group of units may be a certain percentage complete • To obtain an opening inventory balance, the Equivalent Units methodology is used roughly as follows • Estimate to what extent each unit is complete • Multiply the percentage complete by the number of units • Sum all the units

11. Two Methodologies for Calculating Costed Equivalent Units • There are two main methodologies for Calculating Equivalent Units • Weighted Average • No distinction between work done or costs incurred in prior and current periods • Equivalent units of production is the sum of • Units transferred out to the next department or finished goods, plus • Ending Equivalent Units in WIP • Note: Opening Equivalent Units in WIP were Equivalent Units of Production from the preceding period • First-In-First-Out (FIFO) • Distinguishes between work done and costs in different periods

12. Weighted Average Method • Direct Labour and Manufacturing Overhead are often consolidated into a single account called “Conversion” • This is a simplifying step taken as DL is often very small relative to DM and Manufacturing Overhead

13. Weighted Average Method – Equivalent Units of Production • Calculation of Equivalent Units of Production • = Units transferred out plus ending Equivalent Units (definitional) • Assume: • Cost of beginning WIP-Materials was $4,000; WIP-Conversion was $9,000 • Cost of additional production –Materials was $200,000, Conversion was $250,000 • What was the cost per equivalent unit?

14. Cost of beginningwork in processinventory + Cost added during the period Cost perequivalent unit = Equivalent units of production Weighted Average Method • Cost of beginning WIP-Materials was $4,000; WIP-Conversion was $9,000 • Cost of additional production –Materials was $200,000, Conversion was $250,000

15. Cost of beginningwork in processinventory + Cost added during the period Cost perequivalent unit = Equivalent units of production Weighted Average Method

16. Computing the Cost of Units Transferred Out & Ending WIP • These totals will be entered into the Balance Sheet accounts

17. Reconciling Costs • The following exercise will provide a reconciliation, a “check” on your calculations

18. Review • System Design – Process Costing • Review of Process Costing versus Job-Order Costing • When should Process Costing be Used? • How is it Used? • Journal entries • Calculating balances by the Weighted Average Cost method

19. Tutorial • Assignment • Complete Exercises • 4.2 • 4.3 • 4.4 • Preparation for Group Presentations on Monday • Type of Accounting Systems likely to be used by Coke, Nippon, Nike; including why? E.g.: • Product Costing • Process, Job-Order, ABC • Inventory valuation method • FIFO, Average Cost, Other? • Other observations

20. FIFO Method

21. May 15, 2009 • System Design – Process Costing – FIFO Inventory Method • What is FIFO? • FIFO versus Average Cost method • When should FIFO be used? • Journal entries • Calculating balances by the FIFO Cost method

22. FIFO • FIFO is a method of calculating inventory balances • First in - First out • Materials, labour and overhead is drawn into production over time • FIFO attributes the earlier costs drawn to the inventory that leaves the department or finished goods first • FIFO is generally considered more accurate than the Weighted Average method • Better attributes costs in any given period • Identifies cost overruns more quickly and distinctly allowing managers to address problems with minimal delay

23. Equivalent Units – FIFO Method • Back to “Department B” from the Weighted Average Example • This will help us compare the methodologies side-by-side

24. FIFO – Equivalent Units of Production • Calculation of Equivalent Units of Production • = Costs added during the period / Equivalent Units • What was the cost per equivalent unit?

25. Equivalent Units of Production- Reconciling WA to FIFO • The fundamental difference between Equivalent Units of Production under FIFO is that beginning WIP is subtracted from the WA conclusion

26. Cost perequivalent unit Cost added during the period = Equivalent units of production Calculating Unit Cost- FIFO Method • Note: Equivalent Units are usually not the same

27. Computing the Cost ofEnding WIP - FIFO • This total will be entered into the Balance Sheet accounts

28. Computing the Cost ofUnits Transferred Out - FIFO • This total will be entered into the Balance Sheet accounts

29. Reconciling Costs • As with the Weighted Average Method, the following exercise will provide a reconciliation, a “check” on your calculations for the FIFO Method

30. 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.

31. Review • System Design – Process Costing – FIFO Inventory Method • What is FIFO? • FIFO versus Average Cost method • When should FIFO be used? • Journal entries • Calculating balances by the FIFO Cost method

32. Tutorial • Assignment • Review Problem • Complete Alternative Problem 4S-8B (on web site) • Work on Group Presentations due Monday