Process Costing

Chapter 4

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
 4-2

Similarities Between Job-Order and

Process Costing
• Both systems assign material, labor, and overhead
costs to products and they provide a mechanism
for computing unit product costs.
• Both systems use the same manufacturing
accounts, including Manufacturing Overhead, Raw
Materials, Work in Process, and Finished Goods.
• The flow of costs through the manufacturing
accounts is basically the same in both systems.
 4-3

Differences Between Job-Order and

Process Costing
Process costing:
1. Is used when a single product is produced on a
continuing basis or for a long period of time. Job-order
costing is used when many different jobs having
different production requirements are worked on each
period.
2. Systems accumulate costs by department. Job-order
costing systems accumulated costs by individual jobs.
3. Systems compute unit costs by department. Job-order
costing systems compute unit costs by job on the job
cost sheet.
 4-4

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.
 4-5

The Flow of Materials, Labor, and

Overhead Costs
Direct
Materials

Direct Labor Work in Finished

Process Goods

Manufacturing Cost of
Overhead Goods
Sold
 4-6

The Flow of Costs in a Job-Order

Costing System
Costs are traced and
applied to individual
Direct jobs in a job-order
Materials cost system.

Direct Labor Finished

Jobs Goods

Manufacturing Cost of
Overhead Goods
Sold
 4-7

The Flow of Costs in a Processing

Costing System
Costs are traced and
applied to departments
Direct in a process cost
Materials system.

Direct Labor
Processing Finished
Department Goods

Manufacturing Cost of
Overhead Goods
Sold
 4-8

T-Account and Journal Entry Views of

Process Cost Flows
For purposes of this example, assume there
are two processing departments –
Departments A and B.
We will use T-accounts and journal entries.
 4-9

Process Cost Flows: The Flow of Raw

Materials (in T-account form)
Work in Process
Raw Materials Department A
•Direct •Direct
Materials Materials

Work in Process
Department B
•Direct
Materials
 4-10

Process Cost Flows: The Flow of Labor

Costs (in T-account form)
Salaries and Work in Process
Wages Payable Department A
•Direct
•Direct Materials
Labor •Direct
Labor

Work in Process
Department B
•Direct
Materials
•Direct
Labor
 4-11

Process Cost Flows: The Flow of Manufacturing

Overhead Costs (in T-account form)
Work in Process
Department A
Manufacturing •Direct
Overhead Materials
•Direct
•Actual •Overhead Labor
Overhead Applied to •Applied
Work in Overhead
Process
Work in Process
Department B
•Direct
Materials
•Direct
Labor
•Applied
Overhead
 4-12

Process Cost Flows: Transfers from WIP-

Dept. A to WIP-Dept. B (in T-account form)

Work in Process Work in Process

Department A Department B
•Direct Transferred •Direct
Materials to Dept. B Materials
•Direct •Direct
Labor Labor
•Applied •Applied
Overhead Overhead
•Transferred
from Dept. A

Department Department
A B
 4-13

Process Cost Flows: Transfers from WIP-

Dept. B to Finished Goods (in T-account form)
Work in Process
Department B Finished Goods
•Direct •Cost of •Cost of
Materials Goods Goods
•Direct Manufactured Manufactured
Labor
•Applied
Overhead
•Transferred
from Dept. A
 4-14

Process Cost Flows: Transfers from Finished

Goods to COGS (in T-account form)
Work in Process
Department B Finished Goods
•Direct •Cost of •Cost of •Cost of
Materials Goods Goods Goods
•Direct Manufactured Manufactured Sold
Labor
•Applied
Overhead
•Transferred
from Dept. A Cost of Goods Sold

•Cost of
Goods
Sold
 4-15

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.
 4-16

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.
 4-17

Treatment of Direct Labor

Direct
Materials
Direct labor costs
may be small
Dollar Amount

Manufacturing in comparison to
Overhead
other product
Direct costs in process
Labor cost systems.

Type of Product Cost

 4-18

Treatment of Direct Labor

Direct
Materials
Direct labor and
Conversion
manufacturing
Dollar Amount

Direct overhead may be

Labor
combined into
Direct Manufacturing one classification
Labor Overhead of product
cost called
conversion costs.
Type of Product Cost
 4-19

Compute and Apply Costs

The formula for computing the cost per equivalent
unit is:

Cost of beginning
Cost per
Work in Process + Cost added during
equivalent =
Inventory the period
unit
Equivalent units of production
 4-20

Operation Costing
Operation cost is a hybrid of job-order and
process costing because it possesses
attributes of both approaches.

Operation costing is
commonly used when
batches of many
different products pass
through the same
processing department.
 FIFO Method
Appendix 4A

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
 4A-22

FIFO vs. Weighted-Average Method

The FIFO method (generally considered more

accurate than the weighted-average method) differs
from the weighted-average method in two ways:

1. The computation of equivalent units.

2. The way in which the costs of beginning
inventory are treated.
 4A-23

Equivalent Units – FIFO Method

Let’s revisit the Smith Company example. Here is
information concerning the Assembly Department
for the month of June.
Percent Completed
Units Materials Conversion
Work in process, June 1 300 40% 20%

Units started into production in June 6,000

Units completed and transferred out 5,400

of Department A during June

Work in process, June 30 900 60% 30%

 4A-24

Equivalent Units – FIFO Method

Step 1: Determine equivalent units needed to complete
beginning Work in Process Inventory.

Materials Conversion
To complete beginning Work in Process:
Materials: 300 units × (100% - 40%) 180
Conversion: 300 units × (100% - 20%) 240
 4A-25

Equivalent Units – FIFO Method

Step 2: Determine units started and completed during
the period.

Materials Conversion
To complete beginning Work in Process:
Materials: 300 units × (100% - 40%) 180
Conversion: 300 units × (100% - 20%) 240
Units started and completed during June 5,100 5,100
 4A-26

Equivalent Units – FIFO Method

Step 3: Add the equivalent units in ending Work in
Process Inventory.

Materials Conversion
To complete beginning Work in Process:
Materials: 300 units × (100% - 40%) 180
Conversion: 300 units × (100% - 20%) 240
Units started and completed during June 5,100 5,100
Ending Work in Process
Materials: 900 units × 60% complete 540
Conversion: 900 units × 30% complete 270
Equivalent units of production 5,820 5,610
 4A-27

FIFO Example
Materials 6,000 Units Started

Beginning Ending
Work in Process 5,100 Units Started Work in Process
300 Units and Completed 900 Units
40% Complete 60% Complete

300 ×
60%
180 Equivalent Units
5,100 Units Completed
900 ×
540 Equivalent Units 60%
5,820 Equivalent units
of production
 4A-28

FIFO Example
Conversion 6,000 Units Started

Beginning Ending
Work in Process 5,100 Units Started Work in Process
300 Units and Completed 900 Units
20% Complete 30% Complete

300 × 240 Equivalent Units

80%
5,100 Units Completed
900 ×
270 Equivalent Units 30%
5,610 Equivalent units
of production
 4A-29

Equivalent Units:
Weighted-Average vs. FIFO
As shown below, the equivalent units in beginning inventory are
subtracted from the equivalent units of production per the
weighted-average method to obtain the equivalent units of
production under the FIFO method.

Materials Conversion
Equivalent units - weighted-average method 5,940 5,670
Less equivalent units in beginning inventory:
300 units × 40% 120
300 units × 20% 60
Equivalent units - FIFO method 5,820 5,610
 4A-30

Cost per Equivalent Unit - FIFO

Let’s revisit the Smith Company Assembly Department
for the month of June to prepare our production report.
Beginning work in process: 300 units
Materials: 40% complete $ 6,119
Conversion: 20% complete $ 3,920

Production started during June 6,000 units

Production completed during June 5,400 units

Costs added to production in June

Materials cost $ 118,621
Conversion cost $ 81,130

Ending work in process 900 units

Materials: 60% complete
Conversion: 30% complete
 4A-31

Cost per Equivalent Unit - FIFO

The formula for computing the cost per
equivalent unit under FIFO method is:

Cost per Cost added during the period

equivalent =
unit Equivalent units of production
 4A-32

Cost per Equivalent Unit - FIFO

Total
Cost Materials Conversion

Cost added in June $ 199,751 $ 118,621 $ 81,130

Equivalent units 5,820 5,610
Cost per equivalent unit $ 20.3816 $ 14.4617

$118,621 ÷ 5,820 $81,130 ÷ 5,610

Total cost per equivalent unit = $20.3816 + $14.4617 = $34.8433

 4A-33

Applying Costs - FIFO

Step 1: Record the equivalent units of production in ending Work
in Process Inventory.
Assembly Department
Cost of Ending WIP Inventory
Materials Conversion Total
Ending WIP inventory:
Equivalent units 540 270

900 units × 60% 900 units × 30%

 4A-34

Applying Costs - FIFO

Step 2: Record the cost per equivalent unit.

Assembly Department
Cost of Ending WIP Inventory
Materials Conversion Total
Ending WIP inventory:
Equivalent units 540 270
Cost per equivalent unit $ 20.3816 $ 14.4617
 4A-35

Applying Costs - FIFO

Step 3: Compute the cost of ending Work in Process Inventory.

Assembly Department
Cost of Ending WIP Inventory
Materials Conversion Total
Ending WIP inventory:
Equivalent units 540 270
Cost per equivalent unit $ 20.3816 $ 14.4617
Cost of Ending WIP inventory $ 11,006 $ 3,905 $ 14,911

540 × $20.3816 270 × 14.4617

 4A-36

Cost of Units Transferred Out

Step 1: Record the cost in beginning Work in Process Inventory.

Assembly Department
Cost of Units Transferred Out in June
Materials Conversion Total
Cost of Units Transferred Out:
Cost in beginning WIP inventory $ 6,119 $ 3,920 $ 10,039
Cost to complete beginning WIP
Equivalent units to complete 180 240
Cost per equivalent unit $ 20.3816 $ 14.4617
Cost to complete beginning WIP $ 3,669 $ 3,471 7,140
Cost of units started and completed:
Units started and completed 5,100 5,100
Cost per equivalent unit $ 20.3816 $ 14.4617
Cost of units started and completed $ 103,946 $ 73,755 177,701
Cost of Units Transferred Out $ 194,880
 4A-37

Cost of Units Transferred Out

Step 2: Compute the cost to complete the units in beginning
Work in Process Inventory.
Assembly Department
Cost of Units Transferred Out in June
Materials Conversion Total
Cost of Units Transferred Out:
Cost in beginning WIP inventory $ 6,119 $ 3,920 $ 10,039
Cost to complete beginning WIP
Equivalent units to complete 180 240
Cost per equivalent unit $ 20.3816 $ 14.4617
Cost to complete beginning WIP $ 3,669 $ 3,471 7,140
Cost of units started and completed:
Units started and completed 5,100 5,100
Cost per equivalent unit $ 20.3816 $ 14.4617
Cost of units started and completed $ 103,946 $ 73,755 177,701
Cost of Units Transferred Out $ 194,880
 4A-38

Cost of Units Transferred Out

Step 3: Compute the cost of units started and completed this
period.
Assembly Department
Cost of Units Transferred Out in June
Materials Conversion Total
Cost of Units Transferred Out:
Cost in beginning WIP inventory $ 6,119 $ 3,920 $ 10,039
Cost to complete beginning WIP
Equivalent units to complete 180 240
Cost per equivalent unit $ 20.3816 $ 14.4617
Cost to complete beginning WIP $ 3,669 $ 3,471 7,140
Cost of units started and completed:
Units started and completed 5,100 5,100
Cost per equivalent unit $ 20.3816 $ 14.4617
Cost of units started and completed $ 103,946 $ 73,755 177,701
Cost of Units Transferred Out $ 194,880
 4A-39

Cost of Units Transferred Out

Step 4: Compute the total cost of units transferred out.

Assembly Department
Cost of Units Transferred Out in June
Materials Conversion Total
Cost of Units Transferred Out:
Cost in beginning WIP inventory $ 6,119 $ 3,920 $ 10,039
Cost to complete beginning WIP
Equivalent units to complete 180 240
Cost per equivalent unit $ 20.3816 $ 14.4617
Cost to complete beginning WIP $ 3,669 $ 3,471 7,140
Cost of units started and completed:
Units started and completed 5,100 5,100
Cost per equivalent unit $ 20.3816 $ 14.4617
Cost of units started and completed $ 103,946 $ 73,755 177,701
Cost of Units Transferred Out $ 194,880
 4A-40

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.
 Service Department Allocations
Appendix 4B

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
 4B-42

Operating Departments
An operating department carries out
the central purpose of the organization.

The
The Surgery Geography The
Department Department Production
at Mount at the Departments
Sinai University of at
Hospital. Washington. Mitsubishi.
 4B-43

Service Departments
Service departments do not directly
engage in operating activities.

The The Human

Accounting Resources
Department Department
at Macy’s. at Walgreens.
The Cafeteria The Internal Audit
at Genesco. Department at
Exxon.
 4B-44

Interdepartmental Services

Service Operating
Department Department
Costs of the service
department become
overhead costs to
the operating
department.
 4B-45

Allocation Approaches
Direct
Method
Œ
Step-Down 
Method

Reciprocal
Method
Ž
 4B-46

Reciprocal Services

Service Service
Department 1 Department 2
When service
departments provide
services to each
other we call them
reciprocal services.
 4B-47

Direct Method
Service Operating
Interactions Department Department
between service (Cafeteria) (Machining)
departments are
ignored and all
costs are
allocated directly
to operating Service Operating
departments. Department Department
(Custodial) (Assembly)
 4B-48

Step-Down Method
Service Operating
Department Department
Once a service (Cafeteria) (Machining)
department’s costs
are allocated,
other service
department costs
are not allocated
Service Operating
back to it.
Department Department
(Custodial) (Assembly)
 4B-49

Step-Down Method
There are three key points to understand regarding the
step-down method:
ΠIn both the direct and step-down methods, any
amount of the allocation base attributable to the
service department whose cost is being allocated
is always ignored.
 Any amount of the allocation base that is
attributable to a service department whose cost
has already been allocated is ignored.
Ž Each service department assigns its own costs to
operating departments plus the costs that have
been allocated to it from other service departments.
 4B-50

Reciprocal Method
Service Operating
Department Department
Interdepartmental (Cafeteria) (Machining)
services are given
full recognition
rather than partial
recognition as with
the step method. Service Operating
Department Department
(Custodial) (Assembly)

Because of its mathematical complexity,

the reciprocal method is rarely used.