CHAPTER 4
Costing Systems: Process Costing
reviewing the chapter
Objective 1: Describe the process costing system, identify the reasons for its use, and discuss its role in the management process.
1.A process costing system is a product costing system used by companies that produce large amounts of similar products or liquid products or that have a continuous production flow. Companies that produce paint, beverages, bricks, canned foods, milk, and paper are typical users of a process costing system.
2.A process costing system accumulates the costs of direct materials, direct labor, and overhead for each process, department, or work cell and assigns those costs to products as they are produced during a particular period.
3.In the planning process, managers use product cost information to decide what a product should cost and to determine the targeted number of units to be sold. All product-related costs for that targeted number can then be computed and used in the budget. In daily operations, actual costs are incurred as units are produced, and managers are able to compute actual unit costs. Managers evaluate performance by comparing targeted costs with actual costs. If costs have exceeded expectations, they analyze why this has occurred and recommend changes. When managers communicate results to shareholders, they use actual units produced and costs incurred to value inventory on the balance sheet and cost of goods sold on the income statement.
Objective 2: Relate the patterns of product flows to the cost flow methods in a process costing environment.
4.Before a product is completed, it usually must go through several processes, departments, or work cells. For example, a bookcase might go through the cutting, assembling, and staining departments. A process costing system accumulates costs by process, department, or work cell and passes them along to each subsequent process, department, or work cell as the product is being made. At the end of every accounting period, a process cost report assigns the costs that have accumulated during the period to the units that have transferred out of the process, department, or work cell and to the units that are still work in process.
5.A process cost report may use the FIFO costing method or the average costing method to assign the accumulated costs.
a.With the FIFO costing method, the cost flow follows the logical flow of production; the costs assigned to the first materials processed are the first costs transferred out when the materials flow to the next process, department, or work cell.
b.The average costing method does not attempt to match cost flow with product flow; instead, it assigns an average cost to all products made during an accounting period.
Objective 3: Explain the role of the Work in Process Inventory accounts in a process costing system.
6.A process costing system maintains a separate Work in Process Inventory account for each process, department, or work cell. As products move from one process, department, or work cell to the next, the costs associated with them flow to the Work in Process Inventory account of that process, department, or work cell. Once the products are completed and ready for sale, their costs are transferred out of the Work in Process Inventory account to the Cost of Goods Sold account.
7.The process cost report prepared at the end of each period assigns the costs that have accumulated in each Work in Process Inventory account to the units transferred out and to the units still in process. The costs from all processes, departments, or work cells are used in computing the product unit cost.
Objective 4: Define equivalent production, and compute equivalent units.
8.A process costing system assigns the costs incurred in a process, department, or work cell to the units worked on during an accounting period by computing an average cost per unit—that is, by dividing the total manufacturing costs by the total number of units worked on during the period. Equivalent production (also called equivalent units) is calculated to measure the number of equivalent whole units produced during the period. It expresses partially completed units in terms of completed whole units. The number of equivalent units produced is the sum of (a) total units started and completed during the period and (b) an amount representing the work done on partially completed products in both the beginning and the ending work in process inventories. A percentage of completion factor is applied to partially completed units to calculate the number of equivalent whole units.
9.Equivalent production must be computed separately for direct materials and conversion costs. Direct materials are usually added to the production process at the beginning of the process; therefore, equivalent units for materials typically reflect 100 percent completion. Conversion costs, which are the combined total costs of direct labor and overhead, are often incurred uniformly throughout the production process. The computation of equivalent production for conversion costs consists of three components: the cost to finish the beginning work in process inventory, the cost to begin and finish the completed units, and the cost to begin work on the units in the ending work in process inventory.
Objective 5: Prepare a process cost report using the FIFO costing method.
10.A process cost report helps managers track and analyze costs in a process costing system. In a process cost report that uses the FIFO costing method, the cost flow follows the logical physical flow of production—that is, the costs assigned to the first materials processed are the first costs transferred when those materials flow to the next process, department, or work cell.
11.Preparation of a process cost report involves five steps:
a.Steps 1 and 2 account for the physical flow of products and compute equivalent production for both direct materials costs and conversion costs.
b.In Step 3, all direct materials and conversion costs for the current period are added to the costs of beginning inventory to arrive at the total costs to be accounted for.
c.In Step 4, direct materials costs and conversion cost for the current period are divided by their respective units of equivalent production to arrive at the cost per equivalent unit. The cost of beginning inventory is not included in this computation because under the FIFO method, prior period costs are assigned directly to completed units.
d.In Step 5, costs are assigned to the units completed and transferred out during the period, as well as to the ending work in process inventory. The information needed to perform this step is provided by the equivalent units computed in Step 2 and the cost per equivalent unit computed in Step 4. When figures for the cost of ending work in process inventory and the cost of goods transferred out of the department are determined, they are totaled and compared with the total costs to be accounted for (computed in Step 3). If the figures do not agree, the difference is due to rounding or to an error in arithmetic.
12.When a company has more than one production process, department, or work cell, it must have a Work in Process Inventory account for each.
Objective 6: Prepare a process cost report using the average costing method.
13.A process cost report that uses the average costing method involves the same five steps as a process report prepared with the FIFO costing method. However, the procedures for completing some of the steps differ.
a.Step 1 is the same under both the average and FIFO costing methods: the physical units in beginning inventory are added to the physical units started during the period to arrive at total units to be accounted for.
b.In Step 2, the number of units completed and transferred out and the number of units in ending inventory are added to arrive at units accounted for, and the equivalent units for direct materials and conversion costs are computed.
c.In Step 3, all direct materials costs and conversions costs for beginning inventory and the current period are added to arrive at the total costs to be accounted for.
d.In Step 4, the total of the costs in beginning inventory and the current period are divided by the equivalent units to determine the cost per equivalent unit.
e.In Step 5, the costs of the units completed and transferred out are assigned by multiplying the equivalent units for direct materials and conversion (computed in Step 2) by their respective cost per equivalent unit (computed in Step 4) and then totaling these assigned values. The costs of the units in ending work in process inventory are assigned in the same way.
Objective 7: Evaluate operating performance using information about product cost.
14.Product costing systems provide information that managers can use to evaluate an organization's operating performance. Such an analysis may include consideration of the cost trends of a product or product line, units produced per time period, materials usage per unit produced, labor cost per unit produced, special needs of customers, and the cost-effectiveness of changing to a more advanced production process.