Process Costing: The FIFO Method - Detailed Study Notes

Introduction to the FIFO Method in Process Costing

• The FIFO (First-In, First-Out) method is generally considered more accurate than the weighted-average method for process costing.
• Key Characteristics:
  • FIFO calculates unit cost using only the costs outputted from the current period.
  • The explanation of the FIFO method will follow the same four-step process used for the weighted-average method.

Learning Objective 6: Compute Equivalent Units of Production Using the FIFO Method

• This objective focuses on calculating equivalent units when applying the FIFO method.
• Smith Company's Assembly Department - June Example:
  • Step 1: Determine Equivalent Units to Complete Beginning Work in Process (BWIP) Inventory.
    • Materials: $180$ units
    • Conversion: $240$ units
  • Step 2: Add Units Started and Completed During the Period.
    • Materials: $5,100$ units
    • Conversion: $5,100$ units
    • These $5,100$ units are derived by taking the total units completed and transferred out ( $5,400$ units) minus the units in beginning inventory ( $300$ units).
  • Step 3: Add Equivalent Units in Ending Work in Process (EWIP) Inventory.
    • Materials: $540$ units
    • Conversion: $270$ units
• Resulting Equivalent Units:
  • Equivalent units as to materials: $5,820$
  • Equivalent units as to conversion costs: $5,610$
• Visual Computation of Equivalent Units as to Materials:
  • The conceptual formula is: Equivalent Units of Production $=$ Units Completed and Transferred Out $+$ Equivalent Units Remaining in Work in Process.
• Visual Computation of Equivalent Units as to Conversion Costs:
  • The FIFO method differs from the weighted-average method by removing equivalent units that were already in beginning inventory from the weighted-average equivalent units calculation.
  • This approach isolates equivalent units attributable to work performed exclusively during the current period.
• Illustration with Smith Company Example (Comparison to Weighted Average):
  1. Equivalent Units of Production for Materials (Weighted-Average Method): $5,940$ units
     • Minus: Equivalent Units of Material already completed in Beginning Inventory: $120$ units
     • Equals: Equivalent Units of Production (FIFO Method): $5,820$ units
  2. Equivalent Units of Production for Conversion (Weighted-Average Method): $5,670$ units
     • Minus: Equivalent Units of Conversion already complete in Beginning Inventory: $60$ units
     • Equals: Equivalent Units of Production (FIFO Method): $5,610$ units

Learning Objective 7: Compute the Cost Per Equivalent Unit Using the FIFO Method

• This objective focuses on calculating the cost per equivalent unit for the Smith Company's assembly department in June.
• Equivalent Units of Production Calculation (FIFO Method) - Alternative Formulas:
  • Equivalent units to complete beginning work in process inventory $+$ Units started and completed during the period $+$ Equivalent units in ending work in process inventory.
  • Alternatively: Units transferred out $+$ Equivalent units in ending work in process inventory $-$ Equivalent units in beginning work in process inventory.
• Cost Per Equivalent Unit Calculation:
  • Cost per equivalent unit $=$ Cost added during June $ext{/}$ Number of equivalent units.
  • Materials:
    • Cost added: $ext{ extdollar}118,621$
    • Equivalent units: $5,820$
    • Cost per equivalent unit for materials: $ext{ extdollar}118,621 ext{ / } 5,820 ext{ units } hickapprox ext{ extdollar}20.38 ext{ (rounded)}$
  • Conversion:
    • Cost added: $ext{ extdollar}81,130$
    • Equivalent units: $5,610$
    • Cost per equivalent unit for conversion: $ext{ extdollar}81,130 ext{ / } 5,610 ext{ units } hickapprox ext{ extdollar}14.46 ext{ (rounded)}$
  • Total Cost Per Equivalent Unit (Rounded):
    • Total cost per equivalent unit: $ext{ extdollar}34.84$
    • This equals the sum of materials cost per equivalent unit ($ext{ extdollar}20.38$) and conversion cost per equivalent unit ($ext{ extdollar}14.46$).

Learning Objective 8: Assign Cost to Units Using the FIFO Method

• This objective details the process of allocating costs using the FIFO method.

Computing the Cost of Ending Work in Process Inventory

1. Record Equivalent Units of Production in Ending Work in Process Inventory:
   • Materials: $540$ units
   • Conversion: $270$ units
2. Record the Cost Per Equivalent Unit:
   • Materials: $ext{ extdollar}20.38 ext{ (rounded)}$
   • Conversion: $ext{ extdollar}14.46 ext{ (rounded)}$
3. Compute the Cost of Ending Work in Process Inventory (Multiply Units by Cost Per Unit):
   • Materials: $540 ext{ units } imes ext{ extdollar}20.38/ ext{unit} = ext{ extdollar}11,006$
   • Conversion: $270 ext{ units } imes ext{ extdollar}14.46/ ext{unit} = ext{ extdollar}3,905$
   • Total Ending WIP Inventory Cost: $ext{ extdollar}11,006 + ext{ extdollar}3,905 = ext{ extdollar}14,911$

Computing the Cost Transferred Out

1. Record the Cost in Beginning Work in Process Inventory:
   • Materials: $ext{ extdollar}6,119$
   • Conversion Costs: $ext{ extdollar}3,920$
   • Total Beginning WIP Cost: $ext{ extdollar}6,119 + ext{ extdollar}3,920 = ext{ extdollar}10,039$
2. Compute the Cost to Complete Units in Beginning Work in Process:
   • Record Equivalent Units of Production Needed to Complete BWIP:
     • Materials: $180$ units
     • Conversion: $240$ units
   • Record the Cost Per Equivalent Unit:
     • Materials: $ext{ extdollar}20.38 ext{ (rounded)}$
     • Conversion: $ext{ extdollar}14.46 ext{ (rounded)}$
   • Multiply to Compute the Cost to Complete BWIP:
     • Materials: $180 ext{ units } imes ext{ extdollar}20.38/ ext{unit} = ext{ extdollar}3,669$
     • Conversion: $240 ext{ units } imes ext{ extdollar}14.46/ ext{unit} = ext{ extdollar}3,471$
     • Total Cost to Complete BWIP: $ext{ extdollar}3,669 + ext{ extdollar}3,471 = ext{ extdollar}7,140$
3. Compute the Cost of Units Started and Completed This Period:
   • Record Units Started and Completed This Period:
     • Materials: $5,100$ units
     • Conversion: $5,100$ units
   • Record the Cost Per Equivalent Unit:
     • Materials: $ext{ extdollar}20.38 ext{ (rounded)}$
     • Conversion: $ext{ extdollar}14.46 ext{ (rounded)}$
   • Multiply to Compute the Cost of Units Started and Completed:
     • Materials: $5,100 ext{ units } imes ext{ extdollar}20.38/ ext{unit} = ext{ extdollar}103,946$
     • Conversion: $5,100 ext{ units } imes ext{ extdollar}14.46/ ext{unit} = ext{ extdollar}73,755$
     • Total Cost of Units Started & Completed: $ext{ extdollar}103,946 + ext{ extdollar}73,755 = ext{ extdollar}177,701$
4. Final Computation: Add Totals to Compute the Total Cost of Units Transferred Out:
   • Total Cost Transferred Out: ext{ extdollar}10,039 ext{ (BWIP Cost)} + ext{ extdollar}7,140 ext{ (Cost to Complete BWIP)} + ext{ extdollar}177,701 ext{ (Started & Completed)} = ext{ extdollar}194,880

Learning Objective 9: Prepare a Cost Reconciliation Report Using the FIFO Method

• This objective involves reconciling the total costs.

Compute Cost to Be Accounted For

• Cost of Beginning Work in Process Inventory: $ext{ extdollar}10,039$
• Cost Added to Production During the Period: $ext{ extdollar}199,751$
• Total Cost to Be Accounted For (Sum): $ext{ extdollar}10,039 + ext{ extdollar}199,751 = ext{ extdollar}209,790$

Compute Cost Accounted For

• Cost of Ending Work in Process Inventory: $ext{ extdollar}14,911$
• Cost of Units Transferred Out: $ext{ extdollar}194,880$
• Total Cost Accounted For (Sum): $ext{ extdollar}14,911 + ext{ extdollar}194,880 = ext{ extdollar}209,791$

Reconciliation Check

• The Total Cost to be Accounted For ($ext{ extdollar}209,790$) and the Total Cost Accounted For ($ext{ extdollar}209,791$) agree after considering a $ext{ extdollar}1$ rounding error, confirming all costs have been accounted for.

Comparison and Advantages of FIFO Method

• In most situations, the weighted-average and FIFO methods produce very similar unit costs, especially in a lean production environment.
• From a cost control standpoint, the FIFO method is superior to the weighted-average method because it does not mix costs of the current period with costs of the prior period, providing a clearer view of current period performance.