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Process Costing: Understanding Equivalent Units and Cost Allocation

Learn about the concept and purpose of equivalent units, how to assign costs to products using a five-step process, and analyze production cost reports using weighted-average costing and FIFO costing methods.

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Process Costing: Understanding Equivalent Units and Cost Allocation

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  1. Process Costing Chapter 7

  2. 1. Explain the concept and purpose of equivalent units. 2. Assign costs to products using a five-step process. • Assign costs to products using weighted-average costing. 4. Prepare and analyze a production cost report. • Assign costs to products using first-in, first-out (FIFO) costing. • Analyze the accounting choice between FIFO and weighted-average costing. 7. Know when to use process or job costing. • Compare and contrast operation costing with job costing and process costing. Learning Objectives

  3. Job versus Process Costing Job Costing Job 121 Cost of Goods Sold Direct Materials, Direct Labor, and Factory Overhead Finished Goods Job 122 Job 123 Process Costing Process A Direct Materials, Direct Labor, and Factory Overhead Process B Cost of Goods Sold Finished Goods Process C

  4. Equivalent Units 1. Explain the concept and purpose of equivalent units. When manufacturing a product using a continuous process we assume all units have the same costs. Problem: Some units are not completed Answer: Equivalent units

  5. Equivalent Units Continued Equivalent Units (EqU) Number of units that could have been completed with the given costs. Number of units in process Percentage of completion x = EqU 2 x .5 = 1 + = 1 .5 .5

  6. Equivalent Units Continued Jerilee has a big weekend planned. She works Friday night, plans to go to the football game Saturday, and wants to go to the fair on Sunday. She determines she will have ten hours to study. Problem: Jerilee has 10 hours of Accounting and 10 hours of Spanish. Answer: She can do all of her Accounting, all of her Spanish, or some Accounting and some Spanish.

  7. Equivalent Units Continued She can do her Accounting Accounting 10 x 100% = 10 Spanish 0 x 0 = 0 One class finished 10 She can do her Spanish Accounting 0 x 0 = 0 Spanish 10 x 100% = 10 One class finished 10

  8. Equivalent Units Continued She can do half of each Accounting 10 x 50% = 5 Spanish 10 x 50% = 5 Equivalent to one class finished 10 Or a combination Accounting 10 x 60% = 6 Spanish 10 x 40% = 4 Equivalent to one class finished 10

  9. Product Costing in a Process Industry 2. Assign costs to products using a five-step process. Five steps to Costing a Product 1. Measure the physical flow of resources. 2. Compute the equivalent units of production. 3. Identify the product costs for which to account. 4. Compute the costs per equivalent unit. 5. Assign product cost to batches of work.

  10. Assumptions about Costs in WIP How do we account for beginning balance and current period activities and costs? One possibility: weighted average We combine beginning balance and current period activities and costs. Beginning Balance Current Period Prior Period Current Period Unit costs are a weighted average

  11. Assumptions about Costs in WIP Continued Another possibility: FIFO We separate prior period and current period activities and trace the beginning balance and current period costs to the respective units. Prior Period Current Period We assume units from last period are completed and transferred out first. Prior Period then Current Period First-in, First-out (FIFO)

  12. Materials Costs Conversion Costs Units WIP October 1 1,000a $1,113 $194 October activity 5,000 22,487 14,056 Total 6,000 $23,600 $14,250 Transferred out 5,500 WIP October 31 500b Total 6,000 Process Costing: an Example Bart’s Beverages Blending Department a 25% complete with respect to materials and 10% with respect to conversion costs. b 80% complete with respect to materials and 40% with respect to conversion costs.

  13. Process Costing: Weighted Average L.O. 3 Assign costs to products using weighted-average costing. Weighted Average Use the five step process. 1. Measure the physical flow of resources. 2. Compute the equivalent units of production. 3. Identify the product costs for which to account. 4. Compute the costs per equivalent unit. 5. Assign product cost to batches of work.

  14. Step 1: Measure the physical flow of resources. Units Started Units Transferred Out BB EB + = + 1,000a + 5,000 = 5,500 + 500b 6,000 6,000 Total gallons to account for Total gallons accounted for a 25% complete with respect to materials and 10% with respect to conversion costs. b 80% complete with respect to materials and 40% with respect to conversion costs.

  15. Equivalent Units Materials Conversion Transferred out 5,500 5,500 5,500 Work in process, October 31 500 Equivalent units 5,900 5,700 Step 2: Compute the equivalent units of production. Physical Units 400a 200b a 500 units x 80% b 500 units x 40%

  16. Total Costs Materials Costs Conversion Costs $194 $1,307 WIP October 1 $1,113 October costs 14,056 36,543 22,487 Total $14,250 $37,850 $23,600 Step 3: Identify costs for which to account.

  17. Total Materials Conversion WIP, October 1 $1,307 $1,113 $194 October costs 36,543 22,487 14,056 Total costs (Step 3) $37,850 $23,600 $14,250 Step 4: Compute the costs per equivalent unit. Total EqU (Step 2) 5,900 5,700 Cost per EqU $4.00 $2.50

  18. Total Materials Conversion Step 5: Assign product cost to batches of work. Transferred out EqU (Step 2) 5,500 5,500 Cost per EqU (Step 4) $4.00 $2.50 Costs transferred out $35,750 $22,000 $13,750 WIP, October 31 EqU (Step 2) 400 200 Cost per EqU (Step 4) $4.00 $2.50 Costs WIP, October 31 2,100 $1,600 $500 Total cost assigned $37,850 $23,600 $14,250

  19. The Production Cost Report L.O. 4 Prepare and analyze a production cost report. Production cost report A report that summarizes production and costs for a period Why? Used by managers to monitor production and cost flows

  20. Units Equivalent Units Units to be accounted for Physical Materials Conversion WIP beginning inventory 1,000 Units started in this period 5,000 Total units to account for 6,000 Completed and transferred out 5,500 5,500 5,500 WIP ending inventory 500 400a 200b Total units to account for 6,000 5,900 5,700 The Production Cost Report Weighted Average Blending Department Month Ending October 31 Units accounted for a 500 units x 80% b 500 units x 40%

  21. Costs to be accounted for Total Materials Conversion WIP beginning inventory $1,307 1,113 194 Current period costs 36,543 22,487 14,056 Total costs to be accounted for $37,850 $23,600 $14,250 Costs per equivalent unit $4.00c $2.50d Costs assigned to units transferred out 35,750 22,000e 13,750f Costs assigned to WIP ending inventory 2,100 1,600g 500h Total costs accounted for $37,850 $23,600 $14,250 c $23,600/5,900 units d $14,250/5,700 units e $4.00 x 5,500 units f $2.50 x 5,500 units g $4.00 x 400 units h $2.50 x 200 units The Production Cost Report Continued Costs to be accounted for

  22. Assigning Costs using FIFO L.O. 5 Assign costs to products using first-in, first-out (FIFO) costing. FIFO Use the same five step process. 1. Measure the physical flow of resources. 2. Compute the equivalent units of production. 3. Identify the product costs for which to account. 4. Compute the costs per equivalent unit. 5. Assign product cost to batches of work.

  23. Step 1: Measure the physical flow of resources. Exactly the same as weighted average. Units Started Units Transferred Out BB EB + = + 1,000a + 5,000 = 5,500 + 500b 6,000 6,000 Total gallons to account for Total gallons accounted for a 25% complete with respect to materials and 10% with respect to conversion costs. b 80% complete with respect to materials and 40% with respect to conversion costs.

  24. Materials Conversion Step 2: Compute the equivalent units of production. Physical Units Equivalent Units Transferred out 5,500 From WIP October 1 1,000 750a 900b Units started and completed in October 4,500 4,500 4,500 WIP October 31 500 400c 200d Equivalent units 5,650 5,600 a 1,000 units x 75% b 1,000 units x 90% c 500 units x 80% d 500 units x 40%

  25. Total Costs Materials Costs Conversion Costs $194 $1,307 WIP October 1 $1,113 October costs 14,056 36,543 22,487 Total $14,250 $37,850 $23,600 Step 3: Identify costs for which to account. Exactly the same as weighted average.

  26. Step 4: Compute the costs per equivalent unit. Total Materials Conversion October costs $36,543 $22,487 $14,056 Equivalent units (Step 2) 5,650 5,600 Cost per equivalent unit $3.98 $2.51 Note: Include only current period costs and activities.

  27. Step 5: Assign product cost to batches of work. Transferred out Total Materials Conversion Units in WIP October 1 Prior period costs $1,307 $1,113 $194 Complete beginning WIP EU (Step 2) [A] 750 900 Cost per EU (Step 4)[B] $3.98 $2.51 Cost to complete beginning WIP [A x B] 5,244 2,985 2,259 Units started and completed in October Number of units [C] 4,500 4,500 4,500 Cost per EU [B] $3.98 $2.51 Cost of units started, completed and transferred out [B x C] 29,205 17,910 11,295 Total cost of units transferred out $35,756 $22,008 $13,748

  28. Step 5: Assign product cost to batches of work continued Total Materials Conversion Transferred out* $35,756* $22,008* $13,748* WIP, October 31 EU (Step 2) 400 200 Cost per EU (Step 4) $3.98 $2.51 Costs WIP, October 31 2,094 $1,592 $502 Total cost assigned $37,850 $23,600 $14,250 * From previous page

  29. Comparison of FIFO and Weighted Average L.O. 6 Analyze the accounting choice between FIFO and weighted-average costing. FIFO Separates prior period and current period activities and traces the prior period and current period costs to the respective units. Weighted Average Does not separate prior period and current period activities and costs.

  30. Comparison of FIFO and Weighted Average Continued Bart’s Beverages Blending Department Costs to account for $37,850 Weighted Average FIFO Cost per EU $4.00 Materials $3.98 $2.50 Conversion $2.51 $35,750 Cost of goods transferred out $35,756 2,100 Costs WIP, October 31 2,094 $37,850 Costs accounted for $37,850

  31. Choosing between Job and Process Costing L.O. 7 Know when to use process or job costing. Job Costing Process Costing An accounting system that traces costs to individual units or to specific jobs, contracts, or batches of goods. An accounting system used when identical units are produced through a series of uniform production steps. Custom Homes Cornflakes Movies Beverages Services Paint

  32. Operation Costing L.O. 8 Compare and contrast operation costing with job costing and process costing. Job Costing Operation Costing Process Costing An accounting system that traces costs to individual units or to specific jobs, contracts, or batches of goods. A hybrid costing system often used in manufacturing goods that have some common characteristics plus some individual characteristics. An accounting system used when identical units are produced through a series of uniform production steps. Automobiles Computers Clothing

  33. Chapter 7 Finally! Finalmente! The End El Fin

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