Chapter 17 Process Costing.

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1 Chapter 17 Process Costing

2 Job-Costing and Process Costing
Systems Distinct, identifiable units of a product or service Examples: Custom-made machines, Houses Process-Costing Systems Masses of identical or similar units of a product or service Examples: Food, Chemical processing The main difference between process costing and job costing is the extent of averaging used. Jobs consume different quantities of production resources.

3 Illustrating Process Costing
Example: Global Defense Company Manufactures complex electronic components for missiles and military equipments. Focus on the assembly department process for one component, DG-19. All units of DG-19 are identical. The process-costing system for DG-19 in the assembly Department has two categories: direct materials costs, and conversion costs (including manufacturing labor, energy, plant depreciation, and so on). Direct materials are added at the beginning of the assembly process. Conversion costs are added evenly during assembly.

4 Illustrating Process Costing (contd.)
Assembly Department Testing Transfer Conversion costs Added evenly During process Direct materials Added at beginning Of process Process-costing systems separate costs into cost categories according to when costs are introduced into the process.

5 Illustrating Process Costing (contd.)
Three cases: Case 1: Process costing with zero beginning and zero ending work-in-process inventory. Case 2: Process costing with zero beginning work-in-process inventory but some ending work-in-process inventory is incomplete at the end of the period. Case 3: Process costing with both some beginning and some ending work-in-process inventory.

6 Case 1: Process costing with zero beginning and zero ending work-in-process inventory.
On January 1, 2007, there was no beginning inventory of DG-19 units in the assembly department. During January, Global Defense started and completely assembled 400 units. WIP beginning inventory 0 units Started during Jan. 400 units Completed during Jan. WIP ending inventory Direct material costs $32,000 Conversion costs $24,000 Total assembly costs $56,000 By averaging, assembly cost of DG-19 = $56,000÷400= $140 per unit

7 Case 2: Process costing with zero beginning but some ending work-in-process inventory
In Feb. 2007, Global Defense places another 400 units of DG-19 into production. All January production were completely assembled, so NO beginning WIP on February 1. Some customer order late, so not all units started in February are completed by the end of the month Only 175 units are completed. 225 units are partially assembled. Department supervisor estimates that partially assembled units are, on average, 60% complete with respect to conversion costs.

8 Case 2 (contd.) Total costs added (recorded) during February:
Direct Materials: $32,000 Conversion Costs: $ 18,600 Total costs: $50,600 If we want the cost per unit, How we can calculate that ? Is unit cost equal 50,600 ÷ 400 = $126.5 ???? (unit cost has been reduced during Feb. from $140 to $126.5 ?) Can we consider partially assembled units as completed units?? Do both types consume the same amount of resources? What do we mean by Equivalent units?

9 Case 2 (contd.) Physical units Direct materials Conversion costs Total costs WIP, beginning inventory Started during Feb. 400 Completed during Feb. 175 WIP, ending inventory 225 Degree of completion of WIP (partially assembled) 100% 60% Total costs added during Feb. $32,000 $18,600 $50,600

10 Case 2 (contd.) Estimating the degree of completion depends on care, skill, and experience of the estimator, and the nature of the conversion process. A partially assembled units is not the same as fully assembled units regarding costs. Five steps to calculate : The cost of fully assembled units at the end of accounting period. The cost of partially assembled units still in process at the end of accounting period.

11 Case 2 (contd.) Five steps:
Summarize the flow of physical units of output. Compute output in terms of equivalent units Compute cost per equivalent unit Summarize total costs to account for Assign total costs to units completed and to units in ending work in process.

12 Equivalent Units A derived amount of output units that:
Takes the quantity of each input in units completed and in unfinished units of work in process and converts the quantity of input into the amount of completed output units that could be produced with that quantity of input Are calculated separately for each input (direct materials and conversion cost)

13 Equivalent Units (contd.)
Example: 50 physical units were started but not completed by the end of month. These 50 units are estimated to be 70% complete with respect to conversion costs. Assume we put all the conversion costs represented in the 70% into making fully completed units. How many units could have been 100% complete by the end of the month? The answer: 35 units ( 0.70 X 50) If the conversion-cost input in the 50 units in inventory had been used to make completed output units, the company would have produced 35 completed units ( also called equivalent units) of output.

14 Global Defense Example (contd.): DG-19 component

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17 Case 3: Process costing with both some beginning and some ending work-in-process inventory
At the beginning of March 2007, Global Defense had 225 partially assembled DG-19 units. It started production of another 275 units in March. 400 units were completed during march, and 100 units as work-in-process inventory (incomplete units) Two different methods : Weighted-Average Method, and First-In, First-Out Method

18 Case 3 (contd.) Physical Units Direct Materials Conversion Costs
Total Costs WIP, beginning inventory 225 $18,000 $8,100 $26,100 Degree of completion of beginning WIP 100% 60% Started during March 275 Completed during March 400 WIP, ending inventory 100 Degree of completion of ending inventory 50% Total costs added during March only $19,800 $16,380 $36,180

19 Weighted-Average Method
Calculates cost per equivalent unit of all work done to date (regardless of the accounting period in which it was done) Assigns this cost to equivalent units completed and transferred out of the process, and to incomplete units still in process Weighted-average cost is the total of all costs in the Work-in-Process account divided by the total equivalent units of work done to date Five-step procedure.

20 Global Defense Example (contd.): DG-19 component

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22 First-In, First-Out Method
The first-in, first-out (FIFO) method assumes that the earliest equivalent units in work in process are completed first. Work done on beginning inventory before the current period is kept separate from work done in the current period. Costs incurred and units produced in the current period are used to calculate cost per equivalent unit of work done in the current period. In contrast, Weighted-average method merge units and costs in beginning inventory with units and costs of work done in the current period.

23 First-In, First-Out Method (contd.)
The FIFO method: Assigns the cost of the previous accounting period’s equivalent units in beginning work-in-process inventory to the first units completed and transferred out of the process. Assigns the cost of equivalent units worked on during the current period first to complete beginning inventory, next to start and complete new units, and finally to units in ending work-in-process inventory. Five-step procedure is used here

24 The equivalent Units to Complete 225 units
[225 X 0%], [225 X 40%]

25 After finishing the 225 units, cost per unit = 30,780/225= $136.8
Started and completed (175 units), cost per unit = 21,700/175= $124 Ending WIP (100 units), cost per unit= 9,800 /100= $98

26 Transferred-In Costs in Process Costing
Transferred-in costs are cost incurred in previous departments that are carried forward as the product’s cost when it moves to a subsequent process in the production cycle. Transferred-in costs are treated as if they are a separate type of direct material added at the beginning of the process

27 Transferred-In Costs in Process Costing Global Defense Example
Extend Global Defense example to Testing Department. As assembly process is completed, completed DG-19 components are immediately transferred to the Testing Department. In Testing, units receive additional direct material at the end of the process. Conversion costs are added evenly during the testing process. As units are completed in testing, they are immediately transferred to Finished Goods.

28 Transferred-In Costs in Process Costing Global Defense Example (contd
Computation of Testing Department costs consists of: Transferred-in costs Direct material Conversion costs For March 2007: 400 units were transferred from assembly with total cost ($52,000 WAM) or ($52,480 FIFO) Assume case 3 (Process costing with both some beginning and some ending work-in-process inventory) Beginning WIP:240 unit $33,600 transferred-in cost ( 100% completion) $0 Direct Materials (0% completion) $18,000 Conversion costs (62.5% completion)

29 Transferred-In Costs in Process Costing Global Defense Example (contd
For March 2007 (contd.): Completed and transferred out: 440 units WIP ending inventory: 200 unit (100% completion of transferred-in costs, 0% completion of direct materials, 80% completion of conversion costs) Total cost added during March: Direct Materials: $13,200 Conversion costs: $48,600 Transferred-in costs: $52,000 (WAM), OR $52,480 (FIFO)

30 Global Defense Example (contd.)
Assembly Department Testing Transfer Conversion costs Added evenly During process Direct materials Added at end Of process Finished Goods Completed units Transferred from Assembly Dept. Ending WIP Beginning WIP

31 Global Defense Example (contd.)
Physical Units Transferred-in Costs Direct Materials Conversion Costs WIP, beginning 240 $33,600 $0 $18,000 Degree of Completion 100% 0% 62.5% Transferred-in during March 400 WIP, ending inventory 200 Degree of completion 80% Total costs added during March $52,000 OR $52,480 $13,200 $48,600 440 units completed. What is the total costs for completed and ending WIP in Testing Department?

32 Transferred-In Costs and the Weighted-Average Method

33 Transferred-In Costs and the Weighted-Average Method (contd.)

34 Transferred-In Costs and the FIFO Method

35 Transferred-In Costs and the FIFO Method (contd.)

36 Example: Exercise 17-18 Zero beginning Inventory, materials introduced in middle of the process
Vassa Chemicals has a Mixing Department and a Refining Department. Its process costing system in the Mixing Department has two direct materials cost categories ( Chemical P and Chemical Q) and one conversion costs pool. The following data pertain to the Mixing Department for July 2007: Units Costs WIP,July 1 Chemical P $250,000 Units started 50,000 Chemical Q $70,000 Completed 35,000 Conversion costs $135,000

37 Example: Exercise 17-18 (contd.)
Chemical P is introduced at the start of operations in the Mixing Department. Chemical Q is added when the product is three-fourths completed in the Mixing Department (75%). Conversion costs are added evenly during the process. The ending WIP in the Mixing Department is two-thirds complete (66.66%) Compute the equivalent units in the Mixing Dept. for July 2007 for each cost category. Compute the cost of completed units, and the cost of ending WIP as of July 2007.

38 Exhibit 17-18A: (Step 1) (Step 2) Equivalent Units Physical Conversion Flow of Production Units Chemical P Chemical Q Costs Work in process, beginning (given) Started during current period (given) 50,000 To account for Completed and transferred out during current period 35,000 Work in process, ending* (given) 15,000 15,000  100%; 15,000  0%; 15,000  66 2/3% 10,000 Accounted for Work done in current period only 45,000 *Degree of completion in this department: Chemical P, 100%; Chemical Q, 0%; conversion costs, 66 2/3%.

39 Total Production Conversion Costs Chemical P Chemical Q
Total Production Conversion Costs Chemical P Chemical Q (Step 3) Costs added during July $455,000 $250,000 $70,000 $135,000 Divide by equivalent units of work done in current period ¸ 50,000 35,000 40,000 Cost per equivalent unit $5 $2 $3 (Step 4) Total costs to account for (Step 5) Assignment of costs: Completed and transferred out (35,000 units) $350,000 (35,000*  $5) + (35,000*  $2) + (35,000*  $3) Work in process, ending 105,000 (15,000†  $5) (0†  $2) (10,000†  $3) (15,000 units) Total costs accounted for *Equivalent units completed and transferred out from Solution Exhibit 17-18A, Step 2. †Equivalent units in work in process, ending from Solution Exhibit 17-18A, Step 2.