Process Costing Systems
Report for English 4 1999
presented by:
Ralf König
Peter-Köhle-Straße 35
73433 Aalen-Wasseralfingen
1. Process Costing Systems - What is it and when is it
used?
Illustrating process costing
2. Three cases
2.1 Case 1: Process Costing with no beginning
or ending work - in - process inventory
2.2 Case 2: Process costing with no beginning but an
ending work - in - Process Inventory
2.3 Case 3: Process costing with both beginning and ending work - in
- process inventory
3.
Weighted-average method
4. First-In, First-out
Method
5. Transferred-in costs in process costing
5.1 Transferred-in Costs and the
weigthed-average method
5.2 Transferred-in Costs and the FIFO-Method
6. Common Mistakes with Transferred-in Costs
7. Mention of sources
used
1. Process Costing Systems - What is it and
when is it used?
A process-costing system is
a costing system in which the cost of a product or service is obtained by assigning costs
to masses of like or similar units. Unit costs are then computed on an average basis.
Process-costing systems are used in industries that produce like or similar units which
are often mass produced. In these industries, products are manufactured in a very similar
way. The companies usually use the same amount of direct materials, direct manufacturing
labor costs and manufacturing overhead costs. Industries that use process costing systems
are for example: chemical processing, oil refining, pharmaceuticals, plastics, brick and
tile manufacturing, semiconductor chips, beverages and breakfast cereals.
The difference between job costing and
process costing is the extent of averaging used to compute unit costs of product and
services. The cost object in job costing is a job that constitutes a distinctly
identifiable product or service. The quantity of manufacturing resources is different in
any job. It would be incorrect to cost each job at the same average manufacturing cost.
So, when like or similar units are mass produced, process costing averages manufacturing
costs over all units produced.
The costs of a product are important for
inventory calculations, pricing decisions and product profitability analysis. It's also
important for measuring how well the management is done and if costs are reduced
effectively.
Illustrating
process costing
The best way to show how process costing
works, is by example:
Global Defense, Inc, manufactures
thousands of components for missiles and military equipment. One of these is called DG-19.
The product-costing system for DG-19 has a single direct-cost strategy (direct materials)
and a single indirect-cost category (conversion costs). Each unit passes through two
departments: the Assembly Department and the Testing Department. Every effort is made to
make sure that all DG-19 products are identical. Direct materials are added at the
beginning of the process in Assembly. Additional direct materials are added at the end of
processing in the Testing Department. Conversion costs are added evenly during both
processes. They include manufacturing labor, indirect materials, energy, plant
depreciation and so on. After leaving the Testing Department, the DG-19 component is
transferred to Finished Goods.
2. Three cases
2.1 Case 1: Process Costing
with no beginning or ending work - in - process inventory
During January, the first month of the
period, Global Defense starts with the manufacturing process. All units will start and end
in this period. Altogether, Global Defense will manufacture 400 units of DG-19 during this
period.
| Direct materials in this
period: |
$ 32.000 |
| Conversion costs in this
period: |
$ 24.000 |
|
_______ |
| Total Assembly costs in
January: |
$ 56.000 |
Global Defense records direct materials
and conversion costs in the Assembly Department as these costs are incurred. By averaging,
the assembly cost per unit would be $ 56.000 / 400 units = $ 140:
| Direct materials costs by
unit ($32.000 / 400) |
$ 80 |
| Conversion costs per unit ($
24.000 / 400) |
$ 60 |
|
_____ |
| Assembly Department cost per
unit |
$ 140 |
Each unit is identical in this case, so we
assume that all units receive the same amount of direct materials and conversion costs.
The unit costs can be averaged by dividing total costs in a given accounting period by
total units manufactured. This approach is for example used by banks to compute the unit
costs of 100.000 similar customer deposits made in a month. It is usually used by
organizations with mass production of standard units and no incomplete units after the
period.
2.2
Case 2: Process costing with no beginning but an ending work - in - Process Inventory
There is no beginning inventory in
February, because all 400 units produced in January had been fully completed. Due to
customer delays in placing orders, it was only possible to produce 175 units in February.
The 225 partially assembled units as of
February 28 were fully processed with respect to direct materials, because all direct
materials in the Assembly Department are added at the beginning of the assembly process.
Conversion costs are added evenly during the assembly process. Based on the work completed
relative to the total work required to be done, an Assembly Department supervisor
estimates that the partially assembled units were, on average, 60 % complete as to
conversion costs.
Total costs for February:
| Direct materials costs in
February |
$ 32.000 |
| Conversion costs February |
$ 18.600 |
|
_______ |
| Total Assembly Departments
costs |
$ 50.600 |
Problem: How should Global Defense
calculate the cost of fully assembled units and the cost of the partially assembled units
still in process?
The following four steps help us to find
the answer:
| Step 1: |
Summarize the flow of
physical unit of output |
| Step 2: |
Compute output in terms of
equivalent units |
| Step 3: |
Compute equivalent unit costs |
| Step 4: |
Summarize total costs to
account for and assign these cost to units completed and to units in ending work in
process |
Step 1 tracks the physical unit of output.
It shows, where they come from and how many units are there to account for, and where they
go and how they are accounted for.
Step 2 measures the output in equivalent
units, not in physical units, because not all units had been completed. The 400 units are
complete in terms of equivalent units of direct materials, because all direct materials
are added in the Assembly Department at the initial stage of the process. So you count all
400 units in equivalent direct costs.
The 175 fully assembled units are
completely processed with respect to conversion costs. The partially assembled units in
ending process are 60 % complete (on average). Therefore, the conversion costs in 225
partially assembled units is equivalent to conversion costs in 135 (60% of 225) fully
assembled units. So, 310 equivalent units of conversion costs are assembled and
transferred out and 135 equivalent units are in ending work - in - process inventory.
In step 3, equivalent unit costs are
computed by dividing direct materials and conversion costs added during February by the
related quantity of equivalent units of work done in February:
|
Direct costs |
Conversion
costs |
| Costs added during
February: |
$ 32.000 |
$ 18.600 |
| Divide by equivalent
units work done in February: |
/ 400 |
/ 300 |
|
________ |
_________ |
| Cost per equivalent unit
of work done in February: |
$ 80 |
$ 60 |
In Step 4, total costs to account for
are summarized and assigned to units completed and transferred out and to units still in
process at the end of February. Since the beginning balance of the work - in - process is
zero, total costs to account for consist of the costs added during February: direct
materials $ 32.000 and conversion costs $ 18.600.
Direct material costs are 225 times $80
(=$18.000) + Conversion costs: 135 times $60 (=$8.100). Total costs are therefore: $18.000
+ $8.100 = $26.100.
2.3 Case 3: Process costing
with both beginning and ending work - in - process inventory
In march, Global Defense has 225 partially
assembled units in the Assembly Department. During march, Global Defense placed another
275 units into production.
Step 1 traces the physical units of
production. In march, 400 units are completed and transferred out, 100units are in ending
inventory.
Step 2 computes the output in terms of
equivalent units: 275 equivalent units of direct materials and 315 equivalent units of
conversion costs.
Step 3 computes equivalent unit costs.
Direct materials: $ 80; conversion materials: $ 60
Step 4 summarizes total costs to account
for and assigns these costs to units completed and to units in ending work in progress.
The costs that get assigned to each of
these categories depend, as in all inventory accounting, on the specific assumptions
regarding the flow of costs. Next are described to alternative methods, the
weighted-average method and the first-in, first-out method.
3. Weighted-average method
The weighted-average process-costing
method assigns the average equivalent unit cost of all work done to date (regardless of
when it was done) to equivalent units completed and transferred out, and to equivalent
units in ending inventory. The weighted-average cost is simply the average of various
equivalent unit costs entering the work in process account.
4. First-In, First-out Method
The First-in, first-out
(FIFO) process-costing method assigns the cost of the earliest equivalent units available
(starting with the equivalent units in beginning work-in-process inventory. This method
assumes that the earliest equivalent units in work in process - Assembly account are
completed first.
5. Transferred-in costs in process costing
Transferred-in costs (or
previous department costs) are costs incurred in a previous department that are carried
forward as part of the product's cost as it moves to a subsequent department. That means,
costs move with the units when they are transferred to a new department. So, computations
of Testing costs must include transferred-in costs, additional direct materials costs and
conversion costs added in Testing.
The four -step procedure is used to
account for the costs of a subsequent department that has transferred-in costs. Units are
fully completed as to transferred-in costs because these costs are just carried forward
from the previous process. Direct materials costs have a zero degree of completion in both
beginning and ending work-in-process inventories, because in Testing, direct materials are
introduced at the end of the process. That completes steps 1 and 2.
5.1 Transferred-in Costs and
the weigthed-average method
In step 3, the equivalent unit costs are
computed. In step 4, the total costs to account for are summarized, that is the total
debits to Work in Process under the weighted-average method. After that, these costs are
assigned to units completed and to units in ending work-in-process inventory. Beginning
work in process and work done in the current period are totaled and merged together for
purposes of computing weighted-average costs.
A company may split the Work in Process
account into Work in Process - Testing, Transferred-in Costs, Work in Process - Testing,
Direct Materials and Work in Process - Testing, Conversion costs. The journal entries
would contain this detail, though the underlying reasoning and techniques would be
unaffected.
5.2 Transferred-in Costs and
the FIFO-Method
The costs transferred-in from the Assembly
Department are different when the weighted-average rather than the FIFO method is used in
step 3.
In step 4, the total costs to account for
are summarized, consisting of the beginning inventory plus costs added during the current
period, under the FIFO-method. These costs differ from the total debits to Work on Process
under the weighted-average method, because of the different costs of completed units
transferred-in from the Assembly Department under the weighted-average and FIFO methods.
When assigning costs, the FIFO method
keeps the beginning inventory separate and distinct from the work done during the current
period.
Each department in interdepartmental
transfers is regarded as being separate and distinct for accounting purposes. All costs
transferred in during a given accounting period are carried at one unit cost figure,
regardless of whether previous departments used the weighted-average or the FIFO method.
6.
Common Mistakes with Transferred-in Costs
Here are some common pitfalls to avoid
when accounting for transferred-in costs:
- Remember to include transferred-in costs
from previous departments in your calculations. Such costs should be treated as if they
were another kind of direct material added at the beginning of the process. In other
words, when successive departments are involved, transferred units from one department
become all or a part of the direct materials of the next department; however, they are
called transferred-in costs, not direct materials costs.
- In calculating costs to be transferred on a
FIFO basis, do not overlook the costs assigned at the beginning of the period to units
that were in process but are now included in the units transferred.
- Unit costs may fluctuate between periods.
Therefore, transferred units may contain batches accumulated at different unit costs.
- Units may be measured in different terms in
different departments. Consider each department separately. Unit costs could be based on
kilograms in the first department and liters in the second , so as units are received by
the second department, their measurements must be converted to
liters.
7.
Mention of sources used
Cost accounting, chapter 17