Chapter 6 Process Costing Learning Objectives After studying this chapter, you will be able to: 1 Cite examples of businesses in which process costing is used. Explain three common patterns of production flow Determine if a process cost system can be used. bi tion environment. Calculate equivalent production and departmental unit costs Prepare a departmental cost of proxluction report based on average costing. Prepare general journal entries to record production costs in a process cost system. (Appendix) Prepare a departmental cost of production report based on fifo costing ed on an examination of the produc~ In most manufacturing businesses, production costs are accounted for using one of two types of cost accumulation systems: a job order cost system, which was discussed in Chapter 5, or a process cost system, which is discussed in this chapter. This chapter begins with a discussion of the process cost accumulation concept and the environment in which a process cost system is appropriate. In the next section, the process cost accumulation concepts are illustrated by examples of cost of production reports along with the general journal entries required to record the charges to producing departments for costs incurred during the period and for transfers of products from one department to another and finally to Finished Goods Inventory. Process Cost Accumulation An important objective of any costing system is to determine the cost of the goods or services produced by the company. The costing system should be economical to operate and should assign to each product an amount of cost that reasonably reflects the cost of the resources required to manufacture the product. Because each company’s manufactur ing technologies, production organization, and product mixes differ, costing systems should be expected to differ as well. The costing system should be tailored to meet the needs of the company. In job order costing, products are accounted for in batches. Each batch is treated as a separate job, and the job is the cost object. All costs incurred in manufacturing the job are charged to the job cost sheet. If work is performed on a job in more than one department or other cost center, the cost incurred in each cost center is accumulated on the job cost sheet. When the job is completed, the cost per unit of product is determined by dividing the total cost charged to the job cost sheet by the number of units produced on the job. When prod- ucts manufactured during the accounting period within a cost center require different quan- tities and combinations of resources, job order costing is a logical choice because the cost to manufacture different products is not the same. In job order costing, different products can be produced on different jobs and their costs can be separately determined, 616-2 Part 2 > Cost Accumulation In contrast, when all units of product manufactured within a cost center are essentially alike (homogeneous), keeping tack of the cost of separate batches of product is not nec cal, Instead of job order costing, process costing can be used. y overhead are charged to cost cen- essary, and may not be pra Ina process cost system, materials, labor, and facto’ ters. The cost assigned to each unit is determined by dividing the total cost charged to the cost center by the number of units produced. Cost centers are usually departments but may be processing centers within departments. The primary requirement is that all the products manufactured within the cost center during the period must be the same in terms of ned; otherwise, process costing will distort products’ costs. resources const Costing by Departments In manufacturing firms, production can take place in several departments. Each depart- ment performs a specific operation leading to completion of the product. For example, the first department typically performs the starting phase of work on the product, such as cut- ng, stamping, molding, or shaping the product or component parts. When the work in the first department is completed, the units are transferred to a second department, The second department then performs its work, such as assembling, sanding, painting, or packaging, and transfers the units on to the next department, which performs its work, and so forth, until the units are finally completed and transferred to the finished goods storeroom. In a process cost system, materials, labor, and factory overhead are generally charged to the producing departments; however, if a department is organized into two or more cost centers, process costing can still be used, as long as the units of product manufactured within the cost center during the period are homogeneous. For example, a producing department that has four different assembly lines, each producing a different product, can use process costing. Each assembly line can be treated as a separate cost center. This requires keeping a separate record of the costs incurred on each assembly line. Although process costing is discussed and illustrated in the context of a department in this chapter, the concepts apply equally well to other forms of manufacturing organization. The primary criterion for using process costing is that a business unit be identified that produces only one kind of product during each period. Process costing, when practical, is preferable to job order costing because it generally requires less record keeping, and less record keeping means that it costs less to operate. In job order costing, a separate work in process subsidiary record (a job cost sheet) must be kept for each batch of products manufactured, and costs are charged to each batch, In process costing, because all units of product manufactured within a department are homo- geneous, costs are charged only to the producing departments. In job order costing, it is not uncommon for several hundred jobs to be worked on during a single accounting period, requiring a separate record for each job. In contrast, companies that use process costing rarely have more than five to ten producing departments in a single manufacturing facility. requiring only one separate record for each department. The amount of time and effort required to keep track of five to ten departmental cost records is substantially less than the amount of time required to keep track of several hundred job cost records. Process costing is used when products are manufactured under conditions of continu- ous processing or under mass production methods where the products manufactured within a department or other cost center are homogeneous. These conditions often exist in indus- tries that produce such commodities as paper, lumber, pipe, plastics, petroleum, textiles,Chapter 6 > Process Costing 63 steel, wire, bricks, cement, flour, and sugar. Process costing is also used by firms that man ‘facture simple machined parts and small electrical parts (nails. nuts and bolts, light bulbs semiconductor chips. and disks), and by assembly-type industries (automobiles, engine tape recorders, personal computers, and houschold appliances). Some utilities (gas. water and electricity) cost their products using process costing. Physical Production Flow A product can move through a factory in a variety of ways. Three different phys al pro- auetion flow formats associated with process costing are sequential, parallel, and selective. ‘All three are described here to illustrate that process costing can be applied to all patterns of product flow. Sequential Product Flow. In sequential product flow, each product is processed ip the “ame series of steps. In a company with three departments, cutting, assembly, and packag- ing, such a flow can be illustrated as shown in Figure 6-1 ‘Work in Process— _ Cutting Depart Work in Process— er ee tin ree vas | _PelasingBoarment_ ee sy asa FIGURE 6-1 Sequential Product Flow Processing begins in the Cutting Department where raw materials are combined and direct labor and factory overhead costs are added. When work is finished in the Cutting Department, the work moves to the Assembly Department, in which additional direct labor nd overhead costs are incurred. Each department after the first may add more materials ot as in the Assembly Department of this example, may add only labor and factory over, head, After the product has been processed by the Assembly Departinent, itis wansferred to the Packaging Department where more materials, direct labor, and factory overhead are tised, After completion in the Packaging Department, the unit is complete and is trans- ferred to finished goods inventory for storage until it is purchased by a customer Parallel Product Flow. in parallel product flow, certain portions of the work are done simultaneously and then brought cogether in a final process or processes for completion and naungfer to hnighed goods. The accounts shown in Figure 6-2 ilustrate a parallel low for a production process in which materials are added in some of the subsequent departments.6-4 Part 2 > Cost Accumulation Workin Process — ‘Work in Process— Materials Labor H aciary [>> | overtead Factory} ———— Work in Process— Planing and Sanding Department Work in Process— ‘Assembly Department Werk in Process— Painting Depa eee [yaar | Factory var rotad oe _ Soares | | cae Pe Facer ae aan Fite ee ‘overhead | FIGURE 6-2 Parallel Product Flow Processing of wooden parts begins in the Cutting Department, Simultaneously, the processing of metal parts begins in the Melting Department. In both of those departments, materials, labor, and factory overhead are used. Work completed in the Cutting Department is transferred to the Planing and Sanding Department, where additional labor and factory overhead are used. Work completed in the Melting Department is transferred to the Casting Department, where additional labor and factory overhead are used, Work completed in the Planing and Sanding Department and work completed in the Casting Department are both transferred to the Assembly Department, where additional materials, labor, and factory overhead are used. From there the work moves to the Painting Department, where addi- tional materials, labor, and factory overhead are used. Finally the product moves to the fin- ished goods warehouse. Selective Product Flow. In selective product flow, the product moves to different depart- ments within the plant, depending on what final product is to be produced. The accounts shown in Figure 6-3 illustrate a selective flow in a meat processing plant. After the initial butchering process is completed, some of the product goes directly to the Packaging Department and then to finished goods. Some goes to the Smoking Department, then to the Packaging Department, and finally to finished goods. Some goes to the Grinding Department, then to the Packaging Department, and finally to finished goods. Accounting for Materials, Labor, and Factory Overhead Costs Although the amount of record keeping in process costing is less than in job order costing, the basic concepts used in job order costing to accumulate materials, labor, and factory overhead costs also apply to process costing. The primary differences are that in processChapter 6 > Process Costing costing, costs are charged to departments (or cost centers) rather than to jobs, and if more than one department is required to manufacture the product, costs are transferred from one department to the next and eventually to Finished Goods In job order costing, a single work in process inventory account is used rather than & separate one for each job. Keeping a separate general ledger account for each job is not practical where there are many jobs, and because a separate account would have to be temoved from the accounting system when each job is completed. In contrast, in process costing a separate general ledger account may be used for the work in process inventory of each department, because the number of departments is usually small and because departments continue to exist over long periods of time. For example, if there are wo Pro ducing departments, there may be two separate work in process aecounts in the general ledger. Although a single general ledger controlling account for work in process may be used in a process cost system, a separate account will be used for each producing depart ment in this text to emphasize the Mow of costs in a process cost system. Work in Process— _Butchering Department Work in Process— T Materials | Ea SSS ___ Finished Goods | Materials {>_> | tanor reread Work in Process— ‘Smoking Department (oes Labor Faclory overtoad \| Faetory | | Work in Process— Gringing Department Tabor Fac ‘overhead, FIGURE 6-3 Selective Product Flow Materials Costs. In job order costing, materials requisitions are the basis for cha direct materials to specific jobs. In process costing, the details are reduced because mate- tials are charged to departments rather than to jobs, and there are only a few deparimenis tising materials. Materials requisition forms may be useful for contro! of materials. If the requisitions are not priced individually. the cost of materials used can be determined at the6-6 Part 2 > Cost Accumulation end of the production period through a periodic inventory approach-that is, adding pur- es to beginning inventory and deducting ending inventory To illustrate the accounting for materials in a process cost system, ussume the American Chait Company uses a process cost system and maintains separate work in Process accounts in the general ledger for each of its two processing departments, Cuttin; and Assembly. The company manufactures a single style of chair. In the first department, the chair frame is cut out of wood, and its parts are sanded and finished. The frame is trans- ferred to the second department, where frames are assembled and padding and covering are added. During January, direct materials costing $13,608 and $7,296 were used in the Cutting Department and the Assembly Department, respectively. The journal entry to Tecord the issue of materials to the two departments is: el Work in Process—Cutting Department 0... 13,608 Work in Process—Assembly Department... 7,296 Materials Inventory... 20,904 Labor Costs. The detailed clerical work of accumulating labor costs by jobs is eliminated in process costing because labor costs are traced only to departments. Daily time tickets or clock cards are used instead of job time tickets. A summary entry distributes the direct manufacturing payroll to departments for the period. To illustrate the entries for labor, assume that during January 500 direct labor hours were worked in the Cutting Department, and 921 direct labor hours were worked in the Assembly Department. The wage rate is $10 per hour in both departments, so the January charge to production for direct labor is $5,000 and $9,210 for Cutting and Assembly, respectively. The appropriate general journal entry to record the charge for labor is: 5,000 9.210 Work in Process—Cutting Department... Work in Process—Assembly Department. Payroll ise 14,210 Factory Overhead Costs. In both job order and process costing, the actual cost of fac- tory overhead is accumulated in a general ledger control account, and the details of factory overhead costs are accumulated in subsidiary records. In the subsidiary records, each over- head cost item, such as indirect materials or indirect labor, is broken down into amounts for each department. This detailed information is used as a basis for planning future costs and for controlling current costs. As overhead costs are incurred, they are recorded in a fac- tory overhead general ledger account and are posted to the departmental subsidiary records for overhead. The following entry illustrates how actual factory overhead incurred during January would be recorded in the general ledger of American Chair Company. Factory Ovethead COntIO! ennnninnnemnsen 20,900 Accounts Payable (taxes, utlilies, etc.) 7,400 Accumulated Depreciation—Machinery 5,700 Prepaid Insurance ....ssnenno 500 Materials (or indirect mat 1,700 Payroll (for indirect labor). 5,600 Because the actual cost of factory overhead incurred differs each month and is not per- fectly variable with respect to production activity, a predetermined factory overhead rate is often used to smooth factory overhead costs in proportion to production activity through- out the year, Factory overhead is charged to the producing departments at the end of eachChapter 6 > Process Costing 67 month to determine the cost of units manufactured during the month. If predetermined rates are used to apply overhead, the rates are multiplied by the actual amount of the activ y base used in cach producing department. For American Chair Company. factory over head is charged to the producing departments using predetermined rat 60 per machine hour in the Cutting Department and $12 per direct labor hour in the Assembly Department. During January, 1,040 machine hours were used in Cutting and 921 direct labor hours were worked in Assembly, Overhead charged to production for the month is $7,904 in Cutting (1.040 machine hours x $7.60) and $11,052 in Assembly (921 direct labor hours x $12), “The following entry illustrates the charge for factory overhead to the (wo producing departments of American Chair Company in January, assuming that a separate account is used for the applied overhead s of Work in Process—Cutting Department... 7,904 Work in Process—Assembly Department... 11,052 Applied Factory Overhead... snesesen 18,956 The $1,944 difference between the actual factory overhead of $20,900 incurred duri January and the applied amount of $18,956 represents underapplied factory overhead. I the amount of underapplied or overapplied overhead at the end of the year is small relative to other production cost, it would be charged 10 Cost of Goods Sold. Ifthe amount is large, it must be allocated between ending inventories and Cost of Goods Sold for external reporting purposes. The significance and disposition of underapplied and overapplied overhead are discussed in detail in Chapter 12. Combining Labor and Factory Overhead Costs. The preceding illustration shows direst labor being charged separately to each department by means of a general journal entry, Increasing levels of automation cause direct labor to be a decreasing proportion of fotal manufacturing cost. Furthermore, in highly automated factories the distinction between the tasks performed by direct and indirect labor is often blurred. Also, factory overhead costs such as equipment depreciation, power, and maintenance tend to increase ‘vith automation, As a result, some manufacturers combine the labor and factory overhead ost elements and refer to them as conversion cost or simply as factory overhead. Direct Tabor is then not charged separately; instead, a single amount of applied conversion cost is charged to each department. The Cost of Production Report In process costing, all costs chargeable to a department are summarized in @ departmental cost of production report, The cost of production report is # worksheet presenting, the amount of costs accumulated and assigned to production during a month or other period Itis also the source of information for preparing summary journal entries to record the cost of unite wansferred from one producing department to another and finally to finished goods inventory. vA cost of production report for a department can take many forms, but it should show (1) total and unit costs of work received from one or more other departments: (2) total and tunit costs of materials, labor, and factory overhead added by the department; (3) the cost of the beginning and ending work in process inventories; and (4) the cost transferred to a6-8 Part 2 > Cost Accumulation succeeding department or to finished goods. The cost section of the report is usually divided into two parts: one showing total costs for which the department is accountable and the other showing the disposition of these costs. The total cost reported in each of these two sections must be equal. The cost of production report also can include a quantity schedule, which shows the total number of units of product for which a department is accountable and the disposition of these units. Information in the quantity schedule is used to determine the number of equivalent units of production for each element of cost, which in turn is used in determining the departmental unit costs, Determining the cost of the units transferred out of a department and those remaining in ending inventory is essentially an allocation process, Because costs can change over time, a cost flow assumption must be adopted. The most common cost flow assumption used for work in process inventory is average costing; therefore, average costing will be used here for illustrative purposes. (The fifo cost flow assumption is illustrated in the appendix to this chapter.) Next, because units of product in the ending work in process inventories are not completed—at least with respect to some cost elements—then the number of equivalent units, rather than simply physical units, must be computed for each cost element. An equiv- alent unit is the amount of a resource (such as materials, labor, or overhead) that is required to complete one unit of the product. For example, if three units of the product in ending inventory each had one-third of the materials required to complete the product, the total amount of materials used for the three units would be equal to the amount of materials required to complete one unit of product (3 physical units x 1/3 complete = | equivalent unit of materials). Because these units are hypothetical units rather than physical units. they are referred to as equivalent units. To illustrate the cost of production report, assume that American Chair Company uses a process cost system with an average cost flow assumption. The following production data are available for January’ Cutting Assembly Units in Work in Process, beginning inventory s 190 180 Units started in Cutting Department... 600 Units transferred to Assembly Department 500 Units received from Cutting Department 500 Units transferred to Finished Goods inventory bach 580 Units in Work in Process, ending inventory... see 200 100 Departmental supervisors report that ending work in process inventory is 60 percent complete with respect to materials in the Cutting Department and 100 percent complete with respect to materials in the Assembly Department, Ending inventory is 20 percent complete with respect to labor in the Cutting Department and 70 percent complete in the Assembly Department. With respect to factory overhead, ending inventory is 40 percent complete in the Cutting Department and 70 percent complete in the Assembly Department. (The percentages of completion of the beginning work in process inventories are not needed when the average cost method is used.) Cost data for J nuury are: Cutting — Assembly Work in Process, beginning inventory: Cost from preceding department . — $8,320 Matetials.ccccnnn = ‘ soe $1,892 830 Labor eae 400 475 Factory overhead . 2 a 798 8Chapter 6 > Process Costing 69 Cutting Assembly Cost added to process during the current period ‘Materials . $13,608 $ 7.296 Labor ean 5.000 9,210 Factory Overhead 7.904 11,052 The first step in assigning costs is 1o determine the number of equivalent units for each cost element and calculate the cost of each equivalent unit, Because average costing is used by American Chair Company, the cost of each equivalent unit contains a portion of the cost in beginning inventory and a portion of the cost added during the current period. he aver- age cost per equivalent unit for each element of cost is determined by dividing the total cost for each cost element (the amount in beginning inventory plus the amount added dur ing the current period) by the number of equivalent units required to divide that cost between the units transferred out of the department and units in ending inventory. “The units transferred trom Cutting to Assembly are 100 percent complete with respect to all elements of cost added in the Cutting Department (500 equivalent units of materials. labor, and overhead). Ending inventory in the Cutting Department is 60 percent complete as to materials (200 units x 60% complete = 120 equivalent units of materials), 20 percent complete as to labor (200 units x 20% complete = 40 equivalent units of labor), and 40 percent complete as to factory overhead (200 units x 40% complete = 80 equivalent units of factory overhead). Equivalent units for each cost element in the Cutting Department are computed by adding the number of equivalent units transferred out of the department to those in ending inventory as follows Materials Labor Overhead Equivalent units transferred out... 500 500 500 Equivalent units in ending inventory... 129 _40 20 Total equivalent units st 540 580 The average cost per equivalent unit in the Cutting Department is determined as fol- lows: Materials Labor Overhead Cost in beginning inVEMtOry mncnnennesennnnne — $1,802 $ 400 § 796 Cost added during the current period a 13,608 5,000 7,904 Total cost to be accounted for... $15,500 $8,700 Divided by total equivalent units. 620 ‘580 Cost per equivalent UNItenrmnens 25 S15 Based on these data, the January cost of production report for the Cutting Department is presented in Exhibit 6-1. "The journal entry to record the transfer of cost from the Cutting Department 0 the Assembly Department is: Work in Process—Assembly Department 25,000 ‘Work in Process—Cultting Department 25,0006-10 Part 2 > Cost Accumulation American Chair Company Cutting Department Cost of Production Report For January, 20 Quantity Schedule Materials Labor Overhead Quantity Beginning inventory.. ioc 100 Started in process this period Se 600 Transferred to Assembly Department siti 500 Ending inventory. s ti 60% 20% 40% 200 700 Cost Charged to Department aa Eallinient Beginning inventory: Cost Units* Materials... RDOPaernrnscori Factory overhead, Total cost in beginning inventory. . Cost added during the current period Matetial nn 620 $25 Labor .. mupeane ee 540 10 Factory overhead... on cd 7,904 580 15 Total cost added during the current petiod asses $26,512 Total cost charged to the department $50 Cost Accounted for as Follows Percent Equivalent Units Complete Units Unit Cost Cost Transferred to Assembly Department... 500 100 500 $50 $25,000 Work in Process, ending inventory: Materials nn ci 200 60 120 $25 $3,000 LabOF seer 200 20 40 10 400 Factory overhead... 200 40 80 151,200 Total cost accounted for. * Total number of equivalent units required in the cost-accounted-for section (i.e. the sum of the equivalent units for the cost ele- ‘ment listed in the cost-accounted:-fr section of the cost of production report) Total cost (i.e, the cost in beginning inventory plus the cost added during the current period) divided by the total number of equivalent units required in the casi-accounted-lor section EXHIBIT 6-1 Once the cost of the units transferred from the Cutting Department to the Assembly Department has been determined, the cost of production report for the Assembly Department can be prepared. The units transferred from Assembly to Finished Goods are 100 percent complete as to all elements of cost (580 equivalent units of prior department cost, materials, labor and overhead). Ending inventory in the Assembly Department is complete as to prior department cost materials (100 equivalent units of prior department Cost); this is because all units are always complete as to prior department costs. The pre- ceding department would not have transferred units to the next department unless the units transferred were complete with respect to all costs added by the transferring depart- ment, Ending inventory in the Assembly Department is also complete as to materials (100 equivalent units of materials), but it is only 70 percent complete as to conversion costChapter 6 > Process Costing 6-11 (100 units x 70% complete = 70 equivalent units of labor and overhead). Equivalent units for cach cost element in the Assembly Department are computed by adding the number of equivalent units transferred out of the department to those in ending inventory. as follows: From Preceding Department Materials. Labor Overhead Equivalent units transferred out.. 580 580 580 580 Equivalent units in ending inventory 100 100 “70 70 Total equivalent units. 680 680 650 iment is determined as ‘The average cost per equivalent unit in the Assembly Dep; follows: From Preceding Department Materials Labor Cost in beginning inventory. $ 8,320 $ 830 § 475 Cost added during the current period... 25,000 _7.296 9,210 Total cost to be accounted for... $33,320, $8126 $9,685 $11,570 680, 680 650 _ 650 09 $14.95 $14.90 $17.80 Divided by total equivalent units... Cost per equivalent unit int cost per unit is less than the The Assembly Department's $49 of preceding depart unit cost transferred out of the Cutting Department. This occurred because Assembly's cost per unit received from Cutting this period is greater than the cost per unit amount of prior department cost in Assembly's beginning inventory, and the wo different unit costs are averaged in the Assembly Department, using the average cost method. Based on these data, the January cost of production report for the Assembly Department is presented in Exhibit 6~ The journal entry to record the transfer of cost from the Assembly Department to the Finished Goods Inventory is: Finished Goods Inventory... 3 84,317 Work in Process—Assembly Department... 54317 Increase in Quantity of Production When Materials Are Added In some production processes, the addition of materials results in an increase in the total volume or number of units of the product. For example, in the manufacture of soft drink: the syrup is often produced in one department and carbonated water added in a subsequent process. The addition of carbonated water increases the total volume of liquid product to be accounted for. Increasing the quantity of liquid dilutes the amount of syrup in each gal- Ton, which in turn reduces the amount of prior department cost in each gallon of product produced in the second department. The increased quantity of liquid product absorbs the same total amount of preceding department cost6-12 Part 2 > Cost Accumulation ‘Quantity Schedule Beginning inventory a Received from Cutting Department. ‘Transferred to Finished Goods. Ending inventory. - Cost Charged to Department Beginning inventory: Materials. ' Labor Factory overhead. Cost added during the current period: MateFialo : Labor Factory overhead. Total cost charged to the department Cost Accounted for as Follows Transferred to Assembly Department. Work in Process, ending inventory: Cost from preceding department.. Materials ti ne Labotenacisssicsat Factory overhead Total cost accounted for. Cost from preceding department... Total cost in beginning inventory. Cost from the preceding department Total cost added during the current period .. American Chair Company Assembly Department Cost of Production Report For January, 200 Materials 100% Percent Equivalent Units Complete Units 580 100 580 100 400 100 100 100 100 100 70 70 100 70 70 * Total number of equivalent units required in the cost-accounted-or section (i.e. the sum of the equivalent units for the cost ele ment listed in the cost-accounted-for section of the cost of production report). ** Total cost (Le., the cost in beginning inventory plus the cost added during the current period) divided by the total number of equivalent units required in the cost-accounted-for section, Labor 70% 70% Equivalent U 680 $49.00 680 11.95 650 14.90 650 _17.80 $62,701 Unit Cost Total Cost $93.65 $57,317 $49.00 $4,900 11.95 1.195 14.90 1,043 17.80 1,246 EXHIBIT 6-2 To illustrate the preparation of a cost of proc jon report where the addition of mate- rials increases the total quantity of product, assume that in the Mixing Department of Tiger Paint Company, paint dye received trom the Pigment Department is diluted and mixed with a liquid latex base to form paint. The following production data are available for the Mixing Department for April.Chapter 6 > Process Costing Gallons in Work in Process, beginning inventory Gallons received from Pigment Department. Gallons of latex base added in Mixing Department Gallons transferred to Canning Department Gallons in Work in Process, ending inventory ‘The departmental supervisor reports that ending work in process inventory i as to materials and 50 percent complete as to conversion cost. Cost data for April are: Work in Process, beginning inventory: 6-13 800 2,000 4,000 5,800 1,000 s complete Cost from preceding department $1,592 Materials . . 1,692 Labor... 57 Factory overhead : 114 Cost added to process during the current period: Cost from preceding department... see 12,000 Materials 16,940 Labor. 3,660 7,320 Factory overhead .. Average costing is used in the Mixing Department, and overheat! is alloca duction based on labor cost. Units transferred from Mixing to Canning are | ted to pro- 00 percent complete as to all elements of cost added in the Mixing Department (5.800 equivalent units of prior department cost, materials, labor and overhead), and ending inventory i s complete as to prior department cost and materials (1,000 equivalent units of prior department cost ‘and materials) but only 50 percent complete as to conversion cost (1 000 units * plete = 500 equivalent units of labor a in the Mixing Department are: From Preceding Department Materials Labor Equivalent units transferred out... 5,800 5,800 5,800 Equivalent units in ending inventory... 1,000 3,000 500 Total equivalent units. 7 6,800 6,300 “The average cost per equivalent unit in the Mixing Department is determined From Preceding Department Materials Labor Cost in beginning inventory.nnnvmwe $1,832 $1692 S$ 87 Cost added during the current period .. : 12,000 16,940 3,660 Total cost to be accounted for... $13,532 $18,632 $3,717 Divided by total equivalent units... 6,800 6,800 6,300 Cost per equivalent unit... $1.99 $2.74 $59 vAssaming the company keeps a separate general ledger account for each of it the transfer of cost from the Mixing tion departments, the journal entry to record t Department to the Canning Department is: Work in Process—Canning Department .. 37,700 ‘Work in Process—Mixing Department 50% com- \d overhead). Equivalent units for each cost element Overhead 5,800 500 6,300 as follows: Overhead $114 1,320 $7,434 6,300 $1.18 Based on these data, the April cost of production report for the Mixing Department is presented in Exhibit 6-3. produc-6-14 Part 2 > Cost Accumulation Tiger Paint Company Mixing Department Cost of Production Report For April, 204 Quantity Schedule Materials Labor © Overhead Quantity Beginning inventory. ine eee ee 800 Received from the Pigment Department ..ncse oo 2,000 Added to process in Mixing Department. Transferred to Canning Department oe Ending inventory... eines 100% 50% 50% Cost Charged to Department Emiivaiont tink Beginning inventory: Units” Cost** Cost from preceding department Materials. Labor... " Factory overhead... : Total cost in beginning inventory, sm... Cost added during the current period: Cost from the preceding department 6,800 Materials..... m i 6,800 Labor 6,300 Factory overhead. oe 6,300 Total cost added during the current period Total cost charged to the department 6.50 Cost Accounted for as Follows Percent Equivalent Units Complete “Units Unit Cost Total Cost ‘Transferred to Canning Department. 5,800, 100 5,800 $6.50 $37,700 Work in Process, ending inventory: Cost from preceding department... 1,000 100 1,000 $1.99 $1,900 Materials a 7 1,000 100 1,000 2.74 2,740 Labor. 7 1,000 50 500 59 295 Factory overhead. weunin 1,000 50 500 118 590 5,615 Total cost accounted for. ‘ $43,31 * Total number of equivalent units required in the cost-accounted-for section (le., the sum of the equivalent units for the cost ole ‘ment listed in the cost-accounted-for section of the cost of production report), “* Total cost (ie. the cost in Deginning inventory plus the cost added during the current period) divided by the total number of equivalent units required in the cost-accounted-for section. EXHIBIT 6-3 Summary In most manufacturing businesses, production costs are accounted for using one of wo cost accumulation systems: a job order cost system, as discussed in Chapter 5, or a process cost system, as discussed in this chapter. This chapter began by comparing process costing with job order costing, Generally, process costing is a more economical product costing sys- tem than job order costing; however, process costing can be used only when homogeneousChapter 6 > Process Cost Appendix: if, 6-15 products are manufactured within @ department or other cost center. Process cost accumi- Tation concepts were then illustrated by examples of cost of production reports and the related general journal entries required to record charges to producing departments for costs incurred during the period and to transfer costs from one department to another and finally to Finished Goods Inventory Process Costing with a Fifo Cost Flow Assumption The preparation of a cost of production report with a fifo (fi first out) cost flow assumption is demonstrated using the American Chair Company data used in the average cost illustration in this chapter. Recall from that illustration that the following production data are available for January. Cutting Assembly Units in Work in Process, beginning inventory nnn 100 180 Units started in process in Cutting Department... 600 Units transferred to Assembly Department nnn 500 Units received from Cutting Department nn 500 Units transferred to Finished Goods inventory .. 580 Units in Work in Process, ending inventory 200 100 Departmental supervisors report that ending work in process inventory is 60 percent complete with respect to materials in the Cutting Department and 100 percent complete in the Assembly Department. Ending inventory is 20 percent complete with respect to labor in the Cutting Department and 70 percent complete in the Assembly Department, With respect to factory overhead, ending inventory is 40 percent complete in the Cutting Department and 70 percent complete in the Assembly Department Under the fifo cost flow assumption, the cost of the first units transferred out of the department are deemed to come from beginning inventory. If the units in inventory are not complete at the beginning of the period, they must be completed with current period costs before they can be transferred out of the department. The balance of the units to be accounted for contain only current period costs, As a consequence of this inventory layer ing procedure, equivalent units are computed for current period costs only. Total current period equivalent units is the sum of the equivalent units of current period cost addeg to Complete the units in beginning inventory, plus the number of units started and completed during the current period, plus the equivalent units in ending inventory: To compute the equivalent units of current period cost required to complete the units in beginning inven- tory, the stage of completion of the beginning inventory must be known “vesume that the cost of production reports from the preceding month, December. indi- cate that ending inventory in December (the beginning inventory for January) was 80 per- ent complete as to materials in the Cutting Department and 40 percent complete as t0 emerialsin the Assembly Department. Inventory was 40 percent complete as 10 labor in the Cutting Department and 20 percent complete as to labor in the Assembly Department iAs to factory overhead, inventory was 60 percent complete in the Cutting Department and 20 percent complete in the Assembly Department.6-16 Part 2 > Cost Accumulation Cost data for January are: Cutting Assembly Work in Process, beginning inventory: Cost trom preceding department... — — $8,320 Materials sect $ 1,892 830 Labor ssc . Z 400 475 Factory Overh@ad cu oe 796 518 Cost added to process during the current period: Materials. a a 13,608 7,296 Labor 5,000 9,210 Factory overhead. 7,904 11,052 The cost per equivalent unit for each element of current period cost is determined by dividing the cost added during the current period for each cost element by the number of equivalent units of that cost element added in the current period. The number of equivalent units of a cost element added in the current period is the sum of the number required to complete beginning inventory, the number in the units started and completed during the period, and the number in ending inventory, The units of product transferred from Cutting to Assembly are 100 percent complete as to all elements of cost added in the Cutting Department, Of the 500 units transferred, 100 were in beginning inventory. Because beginning inventory was 80 percent complete as to materials, 40 percent complete as to labor, and 60 percent complete as to ovethead, the units in beginning inventory require the addition of only 20 percent of their materials, 60 percent of their labor, and 40 percent of their overhead to be completed, all from current period cost (100 units x 20% to complete = 20 equivalent units of materials; 100 units x 60% to complete = 60 equivalent units of labor; and 100 units x 40% to complete = 40 equivalent units of overhead). The remaining units transferred to Assembly this period contain only current period costs (500 total units transferred ~ 100 from beginning inven- tory = 400 started and completed this period, each of which contains one equivalent unit of materials, labor, and overhead). Ending invemtory is 60 percent complete as to materi- als (200 units x 60% complete = 120 equivalent units of materials), 20 percent complete as to labor (200 units x 20% complete = 40 equivalent units of labor), and 40 percent eom- plete as to overhead (200 units x 40% complete = 80 equivalent units of overhead). Thus the Cutting Department’s current period equivalent units for each cost element are calcu- lated as follows: Materials Labor Overhead Cost added in the current period: Equivalent units in beginning inventory... 20 60 40 Equivalent units started and completed during the current period 400 400 400 Equivalent units in ending inventory..... 120 40 80 Equivalent units of current period cost. 540 500 520 Alternatively, the number of current period equivalent units can be computed by sub- {racting the number of equivalent units in beginning inventory from the total number of equivalent units that would have been computed if average costing were used. This equiv- alence is demonstrated using the same data as follows:Chapter 6 > Process Costing 6-17 Materials Labor Equivalent units transferred out 500 Plus equivalent units in ending inventory _40 Total equivalent units... 540 Less equivalent units in beginning inventory 40 Equivalent units of current period cost... 500 Regardless of which way is used to calculate current period equivalent units, the Cutting Department's current period cost per equivalent unit for each cost element ts deter- mined as follows: Materials Labor Overhead Cost added during the current period... $13,608 $5,000 $7,904 Divided by equivalent units... 540 _ 500 520 Cost per equivalent unit eee $25.20 $15.20 Based on these data, the January cost of production report for the Cutting Department, determined on a fifo basis, is presented in Exhibit 64. ‘Asstuming that the company keeps a separate general ledger account for each of the production departments, the journal entry to record the transfer of eost from the Cutting Department to the Assembly Department is: Work in Process—Assembly Department... 24,960 ‘Work in Process—Cuting Department 24,960 Once the cost transferred from Cutting to Assembly has been determined. the cost of production report for the Assembly Department can be prepared. OF the S80 units trans: ferred from Assembly to Finished Goods during January, 180 were from beginning inven- tory. The units in beginning inventory were complete as to prior department cost as are al units in Cutting: but they are only 40 percent complete as to materials and only 20 percent complete as to conversion cost. The units in beginning inventory required the addition of 60 percent of current period materials (180 units x 60% to complete = 108 equivalent units of materials) and 80 percent of current period conversion cost (180 units x 80% to com- plete = 144 equivalent units of labor and overhead). The remaining units transferred to fin- ished goods this period contain only current period costs (580 total units transferred ~ 180 from beginning inventory = 400 started and completed this period. each of which contains one full equivalent unit of prior department cost, materials, labor, and overhead), Ending inventory is complete as to prior department cost and materials (100 equivalent units of prior department cost and materials) but only 70 percent complete as 10 conversion cost (100 units x 70% complete = 70 equivalent units of labor and overhead). ‘The current period equivalent units in the Assembly Department are determined as follows: From Preceding Department Materials Labor Overhead Costs added in the current period Equivalent units in beginning inventory, = 0 108 144 144 Equivalent units started and completed during the ‘current period nn. 400 400 400 400 Equivalent units in ending inventory... 100 100 70 7 a fe Equivalent units of current period cost... ee 500 608 B14 I IPart 2 > Cost Accumulation ‘American Chair Company Cutting Department Cost of Production Report For January, 208, Quantity Schedule Beginning inventory... Started in process this period .. Transferred to Assembly Department. Ending inventory. aon Cost Charged to Department Beginning inventory: Materials. Labor Factory overhead. Total cost in beginning inventory. Cost added during the current period: Materials Labor Factory overhead. Total cost charged to the department Cost Accounted for as Follows Transferred to Assembly Department From beginning inventory... Cost to complete this period: Materials Labor... Factory Overhead Started and completed this period Total cost transferred to Assembly Department .. Work n Process, ending inveniory Materials Labor... Factory overhead... Total cost accounted for... Total cost added during the current period .. Materials Labor Overhead Quantity 80° 40% 60% 100 600 700 500 60% 20% 40% 200 709 Total Equivalent’ Unit Cost Units" Cost $ 1,892 400 796 $3,088 $13,608 540 $25.20 500 10.00, 520 15.20 $26,512 $29,600 $50.40 Current Equivalent Units Percent Units Unit Cost Total Cost $3,088 100 20 20 $25.20 504 100, 60 60 10.00 600 100 40 40 15.20 608 $ 4,800 400 100, 400 50.40 20,160 24,960 200 60 120 $25.20 $3,024 200 20 40 10.00 400 200 40 80 1520 4.216 4,640 $29,600 * Number of equivalent units of eost added during the current period (i.e. the sum of the equivalent units listed in the cost- accounted:-for section of the cost of production report). “Cost added uring the current period divided by the number of equivalent units of cost added during the current period EXHIBIT 6-4Chapter 6 > Process Costing 619 The cost per equivalent unit added during the current period in the Awe bly Department is determined as follows: From Preceding _Department_ Labor Overhead Cost added during the current period... some $24,960 $7,296 9.210 $11,082 Divided by equivalent units... 500 “608 614 eid Cost per equivalent unit $12.00 15,00 § 18.00 Based on these data, the January cost of production report for the Assembly Department, prepared on a fifo basis, is presented in Exhibit 6-5 ‘The journal entry to record the transfer of cost from the Assembly Department to Finished Goods Inventory is: Finished Goods Inventory. Work in Procoss--Assembly Department. 54,159 Increase in Quantity of Production When Materials are Added To ilustrate the fifo method when a department adds materials that increase the total quan- tity of product to be accounted for, assume the data as given i the Tiger Paint Company illestration. Recall that the Mixing Department receives paint dye [rom the Pigment Department; the dye is mixed with a liquid latex base to fon paint in the Mixing Department. The production data for the Mixing Department for April are: Gallons in Work in Process, beginning inventory .. 800 Gallons received from Pigment Department 2,000 Gallons of latex base added in Mixing Department. 4,000 Gallons transferred to Canning Department... 5,800 17,000 Gallons in Work in Process, ending inventory .. Based on the cost of production report for the month of March, work in process begin- ring inventory for April was 80 percent complete as to materials but only 25 percent as to Conversion costs, The departmental supervisor reported that the ending invent of work in process is complete as to materials and 50 percent complete as 10 conversion. Cost data for the Mixing Department for April are: Work in Process, beginning inventory: ‘Cost from preceding department.....ncnrnsm nat $1,532 Materials oe ccsesserssnennnenneternnnri 11692 Labor sare Senet ener Sv Factory Overhead nnn re irene 14 Cost added to process during the current period: ‘Cost trom preceding department eer oe 42,000 Materials «ne rie mat 16,040 Labor ‘ . ane 3,660 7320 Factory overhead