April 21 Process Costing
April 21, 2014 n System Design Process Costing n Review of Process Costing versus Job-Order Costing n When should Process Costing be Used? n How is it Used? n Journal entries n Calculating balances by the Weighted Average Cost method
Product Costing n Product Costing is the mapping and allocating of costs to a specific product n Its purpose is to provide executives with critical information including: n How to minimize costs n How to price a product competitively and profitably n There are two main methodologies of Product Costing 1. Job-Order Costing each job is different 2. Process Costing many of the same products
Job Order Costing n Job-Order Costing is the costing methodology applied in companies in the following circumstances: n Produce many different products or packages n Manufacture to order so each job is different n Examples would be: n SNC (engineering and construction) n Airbus (aircraft) n Other? n In these cases, a company needs to know, often on an order by order basis, what are the costs associated with fulfilling the order n Cost records for each job will be required to support decision making and billing of the customer
Processing Departments Any unit in an organization where materials, labor, or overhead are added to the product. The activities performed in a processing department are performed uniformly on all units of production. Furthermore, the output of a processing department must be homogeneous. Products in a process costing environment typically flow in a sequence from one department to another.
Process Costing n Process Costing is the costing methodology applied in companies in the following circumstances: n Produce many units of a single product n Each unit is substantially similar to other units n Examples would be: n Lenovo (PC manufacturing) n Frito lay (Snacks and beverages) n Others? n That each of these products are substantially the same, managers are able to apply the same average cost to each unit
Similarities & Differences Between Job- Order and Process Costing n Similarities n Both are Product Costing systems assigning material, labour and overhead to products n Both systems use the same manufacturing accounts n The flow of costs are very similar in both systems n Differences n Process Costing is used for single products which run continuously (versus differing products/packages) n Process Costing tracks cost by department (versus by job) n Tracks unit cost by department (versus by job sheet)
Flow of Materials, Labor and Overhead Costs Direct Materials Costs are traced and applied to departments in a process cost system. Direct Labor Processing Department Finished Goods Manufacturing Overhead Cost of Goods Sold
Processing Departments n The same three inputs go into Work in Process as in Job-Order Costing n In Process Costing, Processing Departments must be identified n A Processing department is any department in which the activities and output are uniform: n Assembly Department n Testing Department n Others? n Inventories get transferred from one department through to the other n Costs are accumulated in each department and average unit costs are used
Process Cost Flows: The Flow of Raw Materials (in T-account form) Raw Materials Direct Materials Work in Process Department A Direct Materials Work in Process Department B Direct Materials
Process Cost Flows: The Flow of Labor Costs (in T-account form) Salaries and Wages Payable Direct Labor Work in Process Department A Direct Materials Direct Labor Work in Process Department B Direct Materials Direct Labor
Process Cost Flows: The Flow of Manufacturing Overhead Costs (in T- account form) Manufacturing Overhead Actual Overhead Overhead Applied to Work in Process Work in Process Department A Direct Materials Direct Labor Applied Overhead Work in Process Department B Direct Materials Direct Labor Applied Overhead
Process Cost Flows: Transfers from WIP- Dept. A to WIP-Dept. B (in T-account form) Work in Process Department A Direct Materials Direct Labor Applied Overhead Transferred to Dept. B Work in Process Department B Direct Materials Direct Labor Applied Overhead Transferred from Dept. A Department A Department B
Process Cost Flows: Transfers from WIP- Dept. B to Finished Goods (in T-account form) Work in Process Department B Direct Materials Direct Labor Applied Overhead Transferred from Dept. A Cost of Goods Manufactured Finished Goods Cost of Goods Manufactured
Process Cost Flows: Transfers from Finished Goods to COGS (in T-account form) Work in Process Department B Direct Materials Direct Labor Applied Overhead Transferred from Dept. A Cost of Goods Manufactured Cost of Goods Sold Cost of Goods Sold Finished Goods Cost of Goods Manufactured Cost of Goods Sold
Process Cost Flows & Journal Entries n Journal entry examples: Journal Entries Debit Credit Comment 1 Raw Materials xx Purchase Raw Materials Accounts Payable xx 2 Work in Progress - Department A xx Direct Materials Work in Progress - Department B xx " Raw Materials xx " 3 Work in Progress - Department A xx Direct Labour Work in Progress - Department B xx " Salaries and Wages Payable xx 4 Work in Progress - Department A xx Work in Progress - Department B xx Manufacturing Overhead xx Allocated on a POHR 5 Work in Progress - Department B xx If Dept B needs to further Process Work in Progress - Department A xx what Dept A has completed 6 Finished Goods xx Work in Process - Deptartment B xx Cost of Goods Manuractured 7 Cost of Goods Sold xx Finished Goods xx
Equivalent Units of Production Equivalent units are the product of the number of partially completed units and the percentage completion of those units. These partially completed units complicate the determination of a department s output for a given period and the unit cost that should be assigned to that output.
Equivalent Units of Production n Usually, there will be some Work in Process Inventory in a department at the beginning of the period n Each unit or group of units may be a certain percentage complete n To obtain an opening inventory balance, the Equivalent Units methodology is used roughly as follows n Estimate to what extent each unit is complete n Multiply the percentage complete by the number of units n Sum all the units Department A Number of Partially Complete Products Percentage Complete Equivalent Units 100 50% 50 500 20% 100 150
Equivalent Units The Basic Idea Two half-completed products are equivalent to one complete product. + = 1 So, 10,000 units 70% complete are equivalent to 7,000 complete units.
Two Methodologies for Calculating Costed Equivalent Units n There are two main methodologies for Calculating Equivalent Units n Weighted Average n No distinction between work done or costs incurred in prior and current periods n Equivalent units of production is the sum of n Units transferred out to the next department or finished goods, plus n Ending Equivalent Units in WIP n Note: Opening Equivalent Units in WIP were Equivalent Units of Production from the preceding period n First-In-First-Out (FIFO) n Distinguishes between work done and costs in different periods
Treatment of Direct Labor Dollar Amount Direct Labor Direct Materials Conversion Direct Labor Manufacturing Overhead Direct labor and manufacturing overhead may be combined into one classification of product cost called conversion costs. Type of Product Cost
Weighted Average Method n Direct Labour and Manufacturing Overhead are often consolidated into a single account called Conversion n This is a simplifying step taken as DL is often very small relative to DM and Manufacturing Overhead in these types of businesses Department B - Weighted Average Percentage Complete Number of Partially Complete Products Units Materials Conversion Beginning WIP 800 50% 30% Units beginning production 40,000 Units complete/transfered out 38,500 100% 100% Ending WIP 2,300 35% 30%
Weighted Average Method Equivalent Units of Production n Calculation of Equivalent Units of Production = Units transferred out plus ending Equivalent Units (definitional) Department B - Weighted Average Percentage Complete Materials Conversion Units complete/transfered out 38,500 38,500 Ending WIP 2,300 * 35% 805 2,300 * 30% 690 Equivalent Units of Production for Period 39,305 39,190 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?
Weighted Average Method Cost per equivalent unit = Cost of beginning work in process inventory + Cost added during the period Equivalent units of production Department B - Weighted Average Percentage Complete Materials Conversion Units complete/transfered out 38,500 38,500 Ending WIP 2,300 * 35% 805 2,300 * 30% 690 Equivalent Units of Production for Period 39,305 39,190 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
Weighted Average Method Cost per equivalent unit = Cost of beginning work in process inventory + Cost added during the period Equivalent units of production Department B - Weighted Average Materials Conversion Cost of Beginning WIP 4,000 9,000 Period production costs 200,000 250,000 Total costs 204,000 259,000 Equivalent units 39,305 39,190 Cost per Equivalent Unit 5.19 6.61 Total cost per EU $ 11.80
Computing the Cost of Units Transferred Out & Ending WIP Department B - Weighted Average Cost of Ending WIP Inventory and Transferred Units Materials Conversion Total Ending WIP Ending Equivalent Units 805 690 Cost per Equivalent Unit 5.19 6.61 Cost of ending WIP 4,178 4,560 8,738 Units completed & transferred Units transfered 38,500 38,500 Cost per Equivalent Unit 5.19 6.61 Cost of units transferred out 199,822 254,440 454,262 n These totals will be entered into the Balance Sheet accounts
Reconciling Costs The following exercise will provide a reconciliation, a check on your calculations Department B - Weighted Average Reconciliation of Costs Costs to be accounted for: Beginning WIP 13,000 Costs added during period 450,000 Total 463,000 Costs accounted for: Cost of ending WIP 8,738 Costs of units transferred out 454,262 Total 463,000
Review n System Design Process Costing n Review of Process Costing versus Job-Order Costing n When should Process Costing be Used? n How is it Used? n Journal entries n Calculating balances by the Weighted Average Cost method
FIFO Method
April 21, 2014 n Process Costing FIFO Inventory Method n What is FIFO? n FIFO versus Average Cost method n When should FIFO be used? n Journal entries n Calculating balances by the FIFO Cost method
FIFO n FIFO is a method of calculating inventory balances n First in - First out n Materials, labour and overhead is drawn into production over time n FIFO attributes the earlier costs drawn to the inventory that leaves the department or finished goods first n FIFO is generally considered more accurate than the Weighted Average method n Better attributes costs in any given period n Identifies cost overruns more quickly and distinctly allowing managers to address problems with minimal delay
Equivalent Units FIFO Method n Back to Department B from the Weighted Average Example Department B - FIFO Percentage Complete Number of Partially Complete Products Units Materials Conversion Beginning WIP 800 50% 30% Units beginning production 40,000 Units complete/transfered out 38,500 100% 100% Ending WIP 2,300 35% 30% n This will help us compare the methodologies side-by-side
FIFO Equivalent Units of Production n Calculation of Equivalent Units of Production Department B - FIFO Percentage Complete Materials Conversion Beginning WIP - % incomplete 800 * 50% 400 800 * 70% 560 Units started & completed 37,700 37,700 Ending WIP 2,300 * 35% 805 2,300 * 30% 690 Equivalent Units of Production for Period 38,905 38,950 Note: Units started & completed = units started less ending WIP units
Equivalent Units of Production - Reconciling WA to FIFO n The fundamental difference between Equivalent Units of Production under FIFO is that beginning WIP is subtracted from the WA conclusion Department B - Weighted Average to FIFO Equivalent units - Weighted Average 39,305 39,190 less Beginning WIP 400 240 Equivalent Units of Production for Period 38,905 38,950
Calculating Unit Cost - FIFO Method Cost per equivalent unit = Cost added during the period Equivalent units of production Department B - FIFO Materials Conversion Period production costs 200,000 250,000 Equivalent units 38,905 38,950 Cost per Equivalent Unit 5.14 6.42 Total cost per EU $ 11.56 n Note: Equivalent Units are usually not the same
Computing the Cost of Ending WIP - FIFO Department B - FIFO Cost of Ending WIP Inventory Materials Conversion Total Ending WIP Ending Equivalent Units 805 690 Cost per Equivalent Unit 5.14 6.42 Cost of ending WIP 4,138 4,429 8,567 n This total will be entered into the Balance Sheet accounts
Computing the Cost of Units Transferred Out - FIFO Department B - FIFO Cost of Tranferring Units Units completed & transferred Cost in Beginning WIP 4,000 9,000 13,000 Cost to complete Beginning WIP Equivalent Units to Complete 400 560 Cost per Equivalent Unit 5.14 6.42 Cost of units started and completed 2,056 3,594 5,651 Cost units completed in period Units started and completed 37,700 37,700 Cost per Equivalent Unit 5.14 6.42 Cost of units started and completed 193,805 241,977 435,782 Total Cost of Units Transferred Out 454,433 n This total will be entered into the Balance Sheet accounts
Reconciling Costs As with the Weighted Average Method, the following exercise will provide a reconciliation, a check on your calculations for the FIFO Method Department B - FIFO Reconciliation of Costs Costs to be accounted for: Beginning WIP 13,000 Costs added during period 450,000 Total 463,000 Costs accounted for: Cost of ending WIP 8,567 Costs of units transferred out 454,433 Total 463,000
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.
Review n System Design Process Costing FIFO Inventory Method n What is FIFO? n FIFO versus Average Cost method n When should FIFO be used? n Journal entries n Calculating balances by the FIFO Cost method
Tutorial n SWOT n Forecasting n Income Statement n 3 years n Formulae for Excel