University Study Notes: Process Costing and Analysis ch 16

Characteristics of Process Operations and Costing

Process operations involve the mass production of similar products using a continuous flow of sequential processes. This standardized method is designed to produce large volumes of uniform goods.

• Sequential Processes: Goods move through separate production departments in a specific order (e.g., from a Roasting Department to a Blending Department).

• Application of Costs: Each process department independently applies direct labor, factory overhead, and direct materials to the products as they move toward completion.

• Completion: The final process in the series completes the goods and makes them ready for sale.

• Industry Examples:

  • General Mills: Cereals.

  • PepsiCo: Beverages.

  • Pfizer: Pharmaceuticals.

  • Kar’s: Trail mix.

  • Procter & Gamble: Household products.

  • Hershey: Chocolate.

  • Coca-Cola: Soft drinks.

  • Suja: Organic juice.

Comparing Process and Job Order Costing

While both systems track direct materials, direct labor, and factory overhead, their flow and cost accumulation differ significantly.

• Job Order Costing:

  • Costs are assigned to specific, unique jobs or batches (e.g., Job 15, Job 16).

  • WIP inventory is tracked per job.

  • The goal is to determine the cost per specific job.

• Process Costing:

  • Costs are assigned to departments or processes (e.g., Roasting Department, Blending Department).

  • WIP inventory is tracked per department.

  • The goal is to determine the cost per unit by summing the costs per unit of each individual department.

Process Costing Steps: Weighted Average Method

The weighted average method for process costing involves four distinct steps to determine and assign costs for a production period.

Step 1: Determine Physical Flow of Units

This step reconciles the units a department is responsible for with where those units ended up at the end of the period.

• Units to Account For: The sum of units in beginning work in process (WIP) and units started during the period.

  • Example: $30,000$ units (Beginning WIP) + $90,000$ units (Started) = $120,000$ total units to account for.

• Units Accounted For: The sum of units completed and transferred out plus units remaining in ending WIP.

  • Example: $100,000$ units (Completed) + $20,000$ units (Ending WIP) = $120,000$ total units accounted for.

Step 2: Compute Equivalent Units of Production (EUP)

Equivalent Units of Production represent the number of units that could have been started and completed given the costs incurred during the period. Because direct materials (DM) and conversion costs (CC) often have different completion levels, EUP is calculated separately for each.

• Weighted Average EUP Formula: $\text{EUP} = \text{Units Completed and Transferred Out} + (\text{Ending WIP Units} \times \% \text{ Complete})$

• Specific Calculation for Roasting Department:

  • Direct Materials: $100,000$ (Completed) + $(20,000 \times 100\%)$ (Ending WIP) = $120,000$ EUP.

  • Conversion: $100,000$ (Completed) + $(20,000 \times 25\%)$ (Ending WIP) = $105,000$ EUP.

Step 3: Compute Cost Per Equivalent Unit of Production

Under the weighted average method, the costs of beginning inventory are combined with the costs added during the current period.

• Total Costs for Roasting Department:

  • Direct Materials: $\$81,000$ (Beginning) + $\$279,000$ (Added) = $\$360,000$

  • Conversion: $\$108,900$ (Beginning) + $\$376,200$ (Added) = $\$485,100$

• Cost per EUP Calculation:

  • Direct Materials: $\frac{\$360,000}{120,000\,EUP} = \$3.00$ per EUP.

  • Conversion: $\frac{\$485,100}{105,000\,EUP} = \$4.62$ per EUP.

Step 4: Assign and Reconcile Costs

Total costs are assigned to the units completed and the units remaining in ending WIP inventory.

• Cost of Units Completed and Transferred Out:

  • Direct Materials: $100,000\,EUP \times \$3.00 = \$300,000$

  • Conversion: $100,000\,EUP \times \$4.62 = \$462,000$

  • Total: $\$762,000$

• Cost of Ending Work in Process:

  • Direct Materials: $20,000\,EUP \times \$3.00 = \$60,000$

  • Conversion: $5,000\,EUP \times \$4.62 = \$23,100$

  • Total: $\$83,100$

• Total Costs Accounted For: $\$762,000 + \$83,100 = \$845,100$

Managerial Use of Process Cost Information

Management utilizes production cost reports for several strategic purposes:

• Control Costs: Comparing current month costs to prior months to identify variances and take corrective action.

• Evaluate Performance: Assessing the efficiency of department managers based on their ability to control costs within their processes.

• Evaluate Process Improvements: Monitoring how costs per EUP change following the implementation of new technology or process changes.

• Financial Reporting: Determining Cost of Goods Sold for the income statement and Ending Inventory for the balance sheet.

Accounting for Process Costing: Journal Entries

The following reflects the flow of costs for GenX during the month of April.

1. Material Costs

• Purchase of Materials:

  • Debit: Raw Materials Inventory $\$400,000$

  • Credit: Accounts Payable $\$400,000$

• Usage of Direct Materials:

  • Debit: Work in Process Inventory—Roasting $\$279,000$

  • Debit: Work in Process Inventory—Blending $\$102,000$

  • Credit: Raw Materials Inventory $\$381,000$

• Usage of Indirect Materials:

  • Debit: Factory Overhead $\$71,250$

  • Credit: Raw Materials Inventory $\$71,250$

2. Labor Costs

• Direct Labor:

  • Debit: Work in Process Inventory—Roasting $\$171,000$

  • Debit: Work in Process Inventory—Blending $\$183,160$

  • Credit: Factory Wages Payable $\$354,160$

• Indirect Labor:

  • Debit: Factory Overhead $\$78,350$

  • Credit: Factory Wages Payable $\$78,350$

3. Factory Overhead

• Recording Actual Overhead Costs:

  • Debit: Factory Overhead $\$275,392$

  • Credit: Prepaid Insurance $\$11,930$

  • Credit: Utilities Payable $\$7,945$

  • Credit: Cash $\$34,867$

  • Credit: Accumulated Depreciation—Factory Equipment $\$220,650$

• Applying Overhead (Predetermined Rate of 120% of Direct Labor):

  • Roasting: \171,000 \times 120\% = \$205,200$

  • Blending: \183,160 \times 120\% = \$219,792$

  • Journal Entry:

    • Debit: Work in Process Inventory—Roasting $\$205,200$

    • Debit: Work in Process Inventory—Blending $\$219,792$

    • Credit: Factory Overhead $\$424,992$

4. Transfers and Sales

• Transfer from Roasting to Blending:

  • Debit: Work in Process Inventory—Blending $\$762,000$

  • Credit: Work in Process Inventory—Roasting $\$762,000$

• Transfer to Finished Goods (from Blending):

  • Debit: Finished Goods Inventory $\$1,262,940$

  • Credit: Work in Process Inventory—Blending $\$1,262,940$

• Recording Sales and Cost of Goods Sold (COGS):

  • Debit: Accounts Receivable $\$1,915,800$

  • Credit: Sales $\$1,915,800$

  • Debit: Cost of Goods Sold $\$1,341,060$

  • Credit: Finished Goods Inventory $\$1,341,060$

Combined Inventory Reporting

As of April 30, inventories are reported as follows on the Balance Sheet:

• Raw Materials: $\$47,750$ (Beg. Inv $+$ Purchases $-$ Materials Requisitioned).

• Work in Process: $\$238,800$ ($\$83,100$ Roasting $+ \$155,700$ Blending).

• Finished Goods: $\$260,400$.

• Total Inventories: $\$546,950$.

Hybrid Costing Systems

Hybrid costing, also known as an operation costing system, combines elements of both process and job order costing.

• Application: Used when products have standardized base processing (process costing) but allow for custom components (job order costing).

• Process Components: Costs for direct materials and conversion that are common to all units are computed using process costing.

• Job Order Components: Costs for additional custom features are tracked individually per job.

• Example: Car Manufacturing:

  • Standard Assembly (Base DM and Conversion): $\$32,600$.

  • Custom Wheels: $\$240$, $\$330$, or $\$480$.

  • Custom Sound System: $\$620$, $\$840$, or $\$1,360$.

Appendix 16A: FIFO Method of Process Costing

The First-In, First-Out (FIFO) method differs from Weighted Average by separating the work and costs from the beginning inventory from the work and costs started in the current period.

FIFO Step 1: Physical Flow of Units

Units accounted for are broken down into three categories:

1. Beginning WIP units completed: Units already in process at the start of the period.

   • Example: $30,000$ units.

2. Units started and completed: Units both started and finished within the current month.

   • Formula: $\text{Units Completed} - \text{Beginning WIP}$

   • Example: $100,000 - 30,000 = 70,000$ units.

3. Ending WIP units: Units started but not yet completed.

   • Example: $20,000$ units.

FIFO Step 2: Compute Equivalent Units

EUP focuses only on current period work Effort:

• Work to complete Beginning WIP: $\text{Units} \times (100\% - \% \text{ complete at start})$

• Units started and completed: $\text{Units} \times 100\%$

• Work on Ending WIP: $\text{Units} \times \% \text{ complete}$

Roasting Department Example (FIFO):

• Direct Materials: $0$ (Beg WIP) $+ 70,000$ (S&C) $+ 20,000$ (End WIP) = $90,000$ EUP.

• Conversion: $10,500$ (Beg WIP: $30,000 \times 35\% \text{ needed}$) $+ 70,000$ (S&C) $+ 5,000$ (End WIP: $20,000 \times 25\% \text{ done}$) = $85,500$ EUP.

FIFO Step 3: Cost per EUP

Only costs added this period are divided by the FIFO EUP.

• Direct Materials: $\frac{\$279,000}{90,000\,EUP} = \$3.10$ per EUP.

• Conversion: $\frac{\$376,200}{85,500\,EUP} = \$4.40$ per EUP.

FIFO Step 4: Assign and Reconcile Costs

Costs are assigned sequentially:

1. Cost of Beginning WIP: Carry over the beginning cost ($\$189,900$).

2. Costs to Complete Beginning WIP: Add costs for the EUP needed to finish these units ($\$46,200$).

3. Cost of Started and Completed Units: $70,000$ units at the current period cost ($\$525,000$).

4. Cost of Ending WIP: Value the ending EUP at current period cost ($\$84,000$).

• Total accounted for: $\$845,100$.