Basic concepts of process costing and average unit costs
Compute average unit costs using process costing.
Five steps in process costing
Describe and calculate equivalent units in process costing.
Weighted-average and FIFO methods
Use and differentiate the weighted-average method and FIFO in process costing.
Job Costing vs. Process Costing
Job-Costing Systems:
Focus on distinct, identifiable units of a product or service.
Examples include custom-made machines and houses.
Process-Costing Systems:
Used for mass production of identical or similar units.
Examples include food and chemical processing.
Process Costing Defined
Process Costing:
A system to assign unit cost of products/services by distributing total costs across many identical or similar units of output.
Unit Costs Calculation:
Unit costs are found by dividing total costs incurred by the number of units produced in the process.
Each unit incurs the same or similar amounts of direct materials, direct manufacturing labor, and manufacturing overhead.
Job Costing vs. Process Costing – Key Differences
A job-costing system varies resource quantities for each job; using an average production cost for all would be incorrect.
Process costing calculates an average production cost applicable to all identical or similar units of production.
Extent of Averaging:
Key distinction lies in how costs are averaged in calculating unit costs.
Process Costing Cost Categories
Cost Categories:
Costs categorized based on timing of introduction into the process:
Direct Materials: Often added at the beginning of production or start of work in a following department.
Conversion Costs: Generally spread evenly throughout the process.
Five Steps of Process Costing Allocation
Summarize the flow of physical output units.
Compute output in terms of equivalent units.
Summarize total costs to account for.
Compute cost per equivalent unit.
Assign total costs to finished units and to units in ending work-in-process.
Equivalent Units (EU)
Definition:
A derived amount equating the quantity of inputs used in completed and unfinished units to the amount of completed output they could produce.
Calculation:
Compute separately for each input; direct materials and conversion costs are considered.
Focus on quantities first, disregarding dollar amounts until after equivalent units are determined.
Further Explanation:
Equivalent units represent the number of complete units that could be obtained from the materials and conversion costs used in partially complete units.
Each complete unit consists of one equivalent unit of each input.
Weighted-Average Process-Costing Method
Overview:
Cost per equivalent unit includes all work done to date, without differentiating the accounting periods.
Costs assigned to equivalent units transferred out and in ending work-in-process inventory.
Calculation:
Weighted-average cost = Total costs in work-in-process account / Total equivalent units of work done to date.
The beginning balance is blended with current period costs.
Key Results from Process Costing Steps
Two critical figures derive from step 5:
Amount for journal entry to transfer costs from work-in-process inventory to finished goods inventory.
Ending balance of the work-in-process inventory to be reported on the balance sheet.
First-In, First-Out (FIFO) Process-Costing Method
Definition:
FIFO assigns the previous period’s equivalent units in beginning work-in-process inventory costs to the first units completed and transferred out.
Costing Sequence:
Costs assigned first to complete beginning inventory, then new units started and completed, followed by units in ending work-in-process.
Key Feature:
Work done on beginning inventory is kept separate from the current period’s work.
Current period costs are used to calculate current per equivalent unit, unlike weighted-average which combines these.
Comparison of Weighted-Average and FIFO Methods
Utility in Decision-Making:
Managers use process-costing information for pricing, product mix decisions, and assessing process performance.
Cost Tracking:
FIFO offers insights into cost variations per unit across periods, facilitating budget performance evaluations.
FIFO is considered more precise compared to weighted-average, which is simpler.
Application:
Both methods are standard in practice and serve different managerial needs based on the granularity of cost information required.