Chapter 6: Process Costing

Chapter 6:Process Costing Cost Accounting: Foundations & Evolutions, 9e Kinney and Raiborn

Learning Objectives • Why are equivalent units of production used in process costing? • How are equivalent units of production, unit costs, and inventory values determined using the weighted average (WA) method of process costing? • How are equivalent units of production, unit costs, and inventory values determined using the first-in, first-out (FIFO) method of process costing? • How are transferred-in costs and units accounted for in a multidepartment production setting? • Why would a company use a hybrid costing system? • (Appendix 1) What alternative methods can be used to calculate equivalent units of production? • (Appendix 2) How are equivalent units of production, unit costs, and inventory values determined using the standard costing method of process costing? • (Appendix 3) How are normal and abnormal spoilage losses treated in an EUP schedule?

Job Order Small quantities of distinct products or service Assign costs to job and then to units within the job Process Costing Large quantities of homogeneous products or services Using an averaging technique, assign costs directly to units produced during the period Job Order vs. Process Costing

Process Costing Numerator • The Numerator - Production Costs • Accumulate costs by department • Accumulate costs by product • Direct material from material requisitions • Direct labor from time sheets and wage rates • Overhead • Actual • Predetermined application rates Unit Cost =Production Costs Production Quantity

Process Costing Denominator • The Denominator - Units Produced • Complicated by work in process • Units started last period and completed this period • Units started this period and not completed • Convert partially completed units to equivalent whole units Unit Cost =Production Costs Production Quantity

Equivalent Units of Production (EUP) • Approximation of the number of whole units of output that could have been produced from the actual effort expended • Includes units • started last period and finished this period • started and finished this period • started this period and not finished • Assumes FIFO physical flow through the production department

Process Costing • Direct material • added at the beginning, during, and/or at the end of the process • Direct labor • added throughout the process • Overhead • added throughout the process • based on direct labor • based on other, multiple cost drivers

Units Costs Process Costing Steps • Units to account for • Units accounted for • Determine equivalent units • Costs to account for • Compute cost per equivalent unit • Assign costs to inventories

Two Process Costing Methods • Weighted Average Method • combines • beginning work in process • current period production • FIFO Method • separates • beginning work in process • current period production

THE DIFFERENCE Process Costing Methods Weighted Average Beginning WIP 100% Started and finished 100% Ending WIP % completed FIFO Beginning WIP % completed Started and finished 100% Ending WIP % completed

Cost of Production Report Name of Department 3 for the period --- Production Data: Units to account for Units accounted for EUP for each cost Cost Data: Costs to account for Cost per EUP Cost Assignment: Transferred Out Ending Work In Process Inventory 2 1 4 5 6

Hybrid Costing Systems • Characteristics of job order and process costing systems • Various product lines • different direct material—job order costing • different direct labor—job order costing • same process—process costing • Hybrid costing used for furniture, clothing, jam, etc.

Process Costing with Standard Costs • Simplify costing process • Eliminate periodic cost recomputations • Same as FIFO computations • emphasize current period costs and production • Inventories are stated at standard cost • Variances are calculated for material, labor, and overhead

Process Costing with Standard Costs • Assigns a “normal” production cost to the equivalent units of output each period • Allows managers to quickly recognize and investigate significant deviations from expected production costs • Allows benchmarking with other firms

Spoilage Normal Spoilage Abnormal Spoilage Loss in all ending inventory and transferred out units on an EUP basis Continuous Loss Period expense in EUP Loss in all units past inspection point in ending inventory and transferred out on an EUP basis Discrete Loss Period expense in EUP

Questions • What is an equivalent unit of production? • What is the difference between the weighted average and FIFO methods of calculating equivalent units? • Why would a company use a hybrid costing system?

Potential Ethical Issues • Over or underestimating completion % for ending WIP inventory to distort results • Using outdated standard costs • Ignoring the assignment of significant direct costs to specific jobs • Treating abnormal spoilage as normal spoilage

Chapter 6: Process Costing