UNIT 10 PROCESS COSTING SYSTEM

Contents

10.0 Aims and Objectives

10.1 Introduction
10.2 The General Characteristics of Process Costing.
10.3 Describe the Five Key Steps In Process Costing
10.4 Process Costing With No Beginning Inventories
10.5 Process Costing under Conditions where there are No Beginning
Inventories and Where Conversion Costs are Not Applied Uniformly.
10.5.1 Process Costing Weighted Average Method
10.5.2 Process Costing and First – In, First - Out Method
10.6 Transfers In Process Costing
10.6.1 Transfers –In and Weighted Average Method
10.6.2 Transfers –In and First –In, First Out Method.
10.7 Summary
10.8 Answers to Check your Progress
10.9 Model Examination Questions.
10.10 Glossary

10.0 AIMS AND OBJECTIVES

After completing this unit, you should be able to:

 Identify the general characteristics of process costing

 Describe the five key steps of process costing
 Demonstrate the weighted average method of process costing.
 Demonstrate the first in, first out method of process costing.
 Demonstrate how transferred in costs affect weighted average process costing.
 Demonstrate how transferred – in costs affect first in, first out process costing.

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10.1 INTRODUCTION

In the precious units, you have seen the accounting cycle of the Job –order-costing
system which is product costing system appropriate to manufacturing firms that
produce custom mode products which differ according to the differences in
customer’s specifications. In this unit the accounting treatment of process costing
system, which is a product costing system used when continuous mass production of
standard products will be discussed.

In process costing the whole process is averaging. The averaging process is affected
by the method of process costing employed. Depending on the nature of the
manufacturing process, the company may use the weighted average or the first in,
first out method. In either of the methods there is a need to accumulate
manufacturing costs using separate work in process general ledger accounts to each
department or process. Then based on the production report, equivalent units are
computed, which are the basis to compute equivalent unit costs. For each cost
element the accumulated material and conversion costs of each process are divided
by the equivalent units of the related cost element in order to determine the
equivalent unit cost of each cost element. Once the equivalent unit cost by each cost
element is determined the accounted costs of each process are applied to the units
completed and transferred out to the next process and to the units remained in the
same process for farther processing in the next period or to the ending work- in
process inventory. The above discussed process will be simple if

1. There are no beginning inventories.

2. There is no abnormal spoilage, shrinkage, or waste
3. The flow of all manufacturing cost is uniformly applied in the manufacturing
processes. If the above three points do not met, the accounting for process costing

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system will be difficult under conditions where the above there points do not meet,
the following cost flow assumptions should be used:
1. Weighted average – method
2. First –in, first –out method. These two methods will be discussed later in
related topics.

10.2 THE GENERAL CHARACTERISTICS OF PROCESS COSTING

The essential characteristics of process costing system are:

 The production is continuous and mass production and the final product is
the result of a sequence of processes or departments.
 Costs are accumulated by processes or operations or department.
 The products are standardized and home generous.
 The cost per unit produced is the average cost which is calculated by dividing
the total process cost by the number of units produced.
 The finished product of each but last process becomes the row material for the
next process.

10.3 DESCRIBE THE FIVE KEY STEPS IN PROCESS COSTING

Introduction: In process costing system to determine the cost per unit of the product,
you need to follow five key steps

Step 1. Summarize the flow of physical units.

Step 2. Compute output in – terms of equivalent units.
Step 3. Summarize the total costs to account for, which are the total debits to work –
in process inventory account of the related process.
Step 4. Compute equivalent unit costs.
Step 5. Apply costs to units completed and to units in the ending WIP inventory.

The first two steps are based on physical or engineering terms. The dollar impact of
the production process is measured in the final three steps and these three steps are
affected by the cost flow assumptions

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To show the transfer of the completed products from mixing dep’t to cooking dep’t
Step 1 Step 2
Equivalent units
Flow of Production Physical units Material Conversion
Cos.
Work – in process beginning -0- (No work done previous
period)
Started during current period 4800
Units to be accounted for 4800
Completed & transferred out:
 From beg. Inventory -0-
 Started & completed 3800 3800 3800
Work in process ending (50% 1000 1000 500
for conversion)
Units accounted for 4800 4800 4300
Equivalent units (work done during current periods) 4800
4300

Details
Direct Conversion
Costs Total
material Cost

Work – in process –beg 0

Costs Added currently 279,100 120,000 159,100
Step.3 Total costs to account for 279,100
Divide by equiv. Units ÷ 4800 ÷ 4300
Step. 4 Equivalent units 6.241 25 37
Step. 5 Applying costs:
Cost Trans. Out 235,600 (3800*62)
W/P Inv, ending:
Material 25,000
Conversion costs (50% ) 185055
Total W/P ending 43500 500(37)
Total costs Accounted for 279100

The above steps should be strictly followed specially when there are beginning
inventories because the final aim of using these fives steps is in order to determine
the amount to be charged to the subsequent dep’t at the end of the period.

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The source of data for the 1st step is the production report which is prepared by the
production supervisor of the respective departments then based on the production
report, the cost accountant will go through the first two steps. The source of data for
the last three steps is the balance of related work in processes inventory. Account in
the general ledger. As Mentioned above when there are beginning inventories in the
processes, (in the general lager), cost flow assumption should be used.

These five steps are the same in either of the product costing methods i.e. either
weighted average or FIFO methods are used.

10.4 PROCESS COSTING SYSTEM

Under process costing where there are no beg balances, the five steps mentioned
above will be simple to apply. The only thing to do is to summarize and compute
equivalent units based on the production report and then to determine the equivalent
unit costs dived the accumulated cost of the related department by the equivalent
units. See the following illustration:

Illustration
Fitsum food processing companies begin operations on Oct 2, 2002. During the
month of October, 4800 units of its product were started in production in the first
department, the mixing Department. Of these, all but 1000 were completed during
the month and transferred out to the second department, the cooking department.
All materials had been added to the 1000 units but only 50% of the labor & overhead
(conversion costs) had been added. The costs increased during the month were
direct materials, $120,000, direct labor $88,000; and manufacturing overhead, $71,100
1) Summarize Physical units and computation equivalent units for mixing
dep’t
2) Determine equivalent unit costs and supply costs to the completed and
the incomplete units
3) Recorded the necessary J. entry to show

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10.5 PROCESS COSTING UNDER CONDITIONS WHERE THERE ARE BEG.
INV AND WHERE MFG. COSTS ARE NOT APPLIED UNIFORMLY.

Introduction: In the previous discussion process-costing system was assumed under

conditions where there are no beginning inventories and where material and
conversion costs are applied uniformly through the manufacturing processes. In this
unit you will learn process costing system where there are beginning inventories and
when materials are applied at the beg of the 1 st process and at the beg or end of the
subsequent process and where conversion costs are uniformly applied through the
processes. Under this condition the two cost flow assumption that may be used are
(1) weighted average process method. (2) FIFO Method

10.5.1 Process costing under the weighted average method.

The weighted average method combines the beginning work – in process inventory
and the manufacturing costs incurred in the current period to determine a single
cumulated total costs to be accounted for, the respective department during a given
period of time usually a month. This cumulative amount is the summation of the
total manufacturing cost elements. The total of each cost element is divided by the
equivalent units of the related cost element in order to determine equivalent unit cost
to each cost element. The equivalent unit cost is then the basis to apply costs to the
units completed and transferred out and the units, which are to remain in the ending,
work in process inventory.

Illustration:
A Company has two processes. Material is introduced at the beginning of the
process in Dep’t A, is completed, goods are immediately transferred to department B,
A goods are completed in Department B, then they are transferred out to finished
goods inventory.

The Company adds direct materials at the beginning of the process in department

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 A. Conversion cost was 75%. Complete as to the 8000 units in working process on
may 1, 2002, and 50% complete as to the 6000 units in work in process on may 31,
2002. During May, 12,000 units were completed and transferred out to Department B
Analysis of the costs relating to work –in process and the production activity for may
are follows:
Costs
Direct materials Conversion costs
Work in process, beginning Br. 9,600 Br. 4,800
Costs added in may 15,600 14,400

Required:
(1) Determine the cost of the units completed and transferred out to department B.
(2) Determine the cost of the units work in process, ending
Solution
To do the above illustration, we should apply the five key steps in process costing as
follow:
Step 1 Steps 2
Physical units Equivalent units
Flow of production Direct Material costs Conversion Costs
Work in process Beginning 8,000
Started in current period 10,000
Units to account for 18,000
Completed and Transferred Out 12,000 12,000 12,000
Work – in process, ending 6,000 6,000 3,000
Units accounted for 18,000
Equivalent units 18,000 15,000

Total Costs Direct material costs Conversion costs

Steps 3: Total costs to account for

Work – in process, beginning Br 14,400 Br. 9,600 Br. 4,800
Costs added currently 30,000 15,600 14,400
Cost to account for Br. 44,400 Br. 25,200 Br.19,200
Step 4. Equivalent unit costs
Total costs to account for divided by Br.25,200/18000 Br.19,200/15000

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equivalent units = Br.1.4 = Br.1.28

Step 5. Applying costs:

Completed & transferred out Br. 32,160 12,000×1.4=16,800 12,000×1.28=15,360
Work in process, ending Br.12,240 6,000×1.4= 8,400 3000×1.28=3,840
Total Costs accounted for Br.44,400 Br.25,200 Br.19,200

First In First out method

In process costing system under the assumption of first in first out method the
equivalent unit cost to each cost element is determined based on the costs incurred in
the current period and the equivalent units of each cost element. The computed
equivalent cost is then the basis to apply costs to the units completed and transferred
out to the next department or to finished goods if it is the last department in the
process and also to the work in process units.

The five key steps in process costing are used in FIFO method too. The 1 st step,
which is the summary of physical units, will be the same under both methods,
weighted average and first in first out methods.

But the last four steps are different in FIFO methods. The reason is, FIFO method
does not include the units from the beginning inventory in determining the
equivalent units. The equivalent units are based on the work done in the current
period. It also excludes the costs in the beginning WIP inventory in the computation
of equivalent unit costs. Equivalent unit costs are computed by dividing the costs,
which are incurred in the current period by the equivalent units (work done) in the
same period. Therefore the out come of the last four steps discussed above are
different under FIFO method as compared to weighted average method.

To understand the FIFO Method, let us use the same illustration we used for
weighted average method. To determine the cost of the units completed and ending
work in process inventory we need to follow the five steps discussed above:

Step 1. Summary of physical units.

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 Work in process, beg…………10,000 units
Started in current period.10, 000 units
Units be accounted for. 20,000 units

As mentioned above the physical units are the same under FIFO and weighted
average.
Step 2. Compute equivalent units.
Direct material Convention
cost
Completed and trans. Out. 12,000 12,000
Work – in – process, ending 6,000 3,000
Total 18,000 15,000
Less: work – in- process beg. 10,000 4,000
Equivalent units 8,000 11,000

There is an alternative method to determine the equivalent units under FIFO method:

Direct material Convention

cost
Work in process, beg. ---- 6,000
Started and completed. 2,000 2,000
Work – Process, ending. 6,000 3,000
Equivalent units 8,000 11,000
Step 3. Compute summary of cost:
Total Dm CC
Work in process begs. 14,400
Costs Added current period 30,000 15,600 14,400
Total Costs to be accounted for 44,400
Divided by equivalent units ÷ 8000 ÷ 11,000
Step 4. Equivalent units Br.1.95 Br. 1.31
Step 5. Applying Costs

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 Completed and transferred out (12,000 units):
Work – in process, beg. (10,000) ……… Br. 14,400
Cost Added currently
Conversion costs 7860
6000(1.31)
Total from WiP beg. 22,260
Start & completed (2000) 6,500 2000(3.26)
Total from WiP beg. 28,780
Work in process, ending (6000) 11,700 – 6000(1.95)
Direct material 3,900
Conversion cost 15,630
To Detected Total WiP 3000(1.3)
Comparison of FIFO and weighted average methods

FIFO process costing is based on the work done (equivalent units of production) and
costs of the current period. It gives accurate information of current costs of materials
and conversion costs per unit of the product.

In weighted average process costing, the costs in the beg WiP inventory are added to
the current periods cost. The total of the beg costs in the WiP inventory and current
cost is then divided by the total of the equivalent units. The beginning WiP inventory
represents the work done in the previous period, it will be averaged in with the
current periods equivalent units computation.

10.6 TRANSFERS IN PROCESS COSTING

In some manufacturing firms there are two or more processing departments. When
physical goods are flowing from one-production departments to the other, the
related manufacturing costs are also transferred by making journal entries. The
transfer is simple when standard costs are used as compared used to FIFO or
weighted average is used.

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In process costing when there is transfer in costs, the accountant should compute:
(1) The costs of goods completed and transferred out, These cost includes:
 The transferred – in cost
 The current material cost
 The current conversion costs
The goods, which are completed and transferred to the next department, are
composed of:
 Beginning. WiP Inventory
 Goods started currently and completed.
(2) The cost of the ending W/P inventory i.e. the cost of the goods remained
incomplete in the department.
(3) Record the Journal entries to transfer costs of completed goods to the WiP
inventory of the next department.

10.6.1 Transfers in under weighted average method assumption

The same five steps will be followed

The 1st and 2nd step are the same, except that the transferred in units are included in
computing physical units and equivalent units in step 1 and step 2 respectively.

See the following illustration:

Fasica factory, toy manufacturer has two departments, forming and finishing,
consider the finishing department, which processes the formed toys through the
addition of hand shaping and metal. Various direct materials are added at various
stages to complete the product. Assume all additional direct materials are added at
the end of the process1.

The following are dates for April operations in the finishing department
Units:

1
Direct material in subsequent production departments can be added either at the beginning or ending or various
stages for acting purpose either in added at the beginning or ending only.

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  WIP, March 31, 5000 units, 60% completed, for conversion costs.
 Units transferred in during April, 20,000
 Units completed during April, 21,000
 WIP, April 30, 4000units, 30% completed, for conversion costs.

Costs:
WIP, March 31. (Transferred – in costs, Br. 17,750;
Conversion costs, Br. 7250…………………………………….Br. 25,000
Transferred in costs from Forming dep’t during April…………….104,000
Direct materials added during April………………………………... 23,100
Conversion Costs added during April ……………………………… 38,400
Total cost to account for. ………………………………………Br. 190,500
Required:
(1) Use the weighted average method. Prepare schedule of output in equivalent
units.
Prepare a production report for the finishing Department for April.
(2) Prepare Journal entries for April transfers from the forming Department to the
finishing Department and from the finishing department to finished goods
Inventory.

To do the above illustration, you should follow the five key steps.
Step 1. Computing physical units
Beginning Inventory…………………………………………..5000 unit
Transferred in units…………………………………….……20,000units
Physical units to be accounted for.25, 000
Step 2. Computing equivalent units:
Transferred
In –costs Dm CC
Transferred out units. 21,000 21,000
21,000

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W/P ending (4000 units) 30%completed for CC 4000
1200
Equivalent units 25,000 21,000
22.200
Step 3. Computing costs to be accounted for:
Total Transferred Dm CC
In – costs
Beg. WiP Inv. Br. 25,000 Br. 17750 -- Br. 7250
Costs added during current period 165,500 10,400 23100
38400
Total costs to be accounted for Br.190, 500 Br.121, and 750 Br.23100 Br.45,
650
Divided by equivalent units in step 2 --- ÷ 25000 ÷ 21000 ÷
22200

Step 3. Equivalent unit costs Br. 4.87 Br. 1.1

0.0563

Step 4. Application of costs

Costs of Transferred out --- 21000 ()
W/P ending
Tran. In 4000 ()
Dm ---
CC --- 1200 ()
Total WiP end ---
Costs Accounted for XX

Instruction No 2
O. Entries:
To transfer costs from forming to finishing Dep’t:

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WiP finishing XX
WiP - Forming XX
To transfer costs from finishing Dep’t to the finished goods Inv. Account.
FG. Inv entry-------------XX
WiP – finishing Dep’t-------------XX

10.6.2 Transfers – In under FIFO method assumption

The application of FIFO cost flow assumption considers only the work done in the
current period to compute the equivalent units and the equivalent unit costs which
are the basis to determine the cost of completed and transferred out to the next
department or to the finished goods inventory and the cost of the ending work – in
process that represents the cost of incomplete units remained at for further
processing in the same dep’t for the next period.

To show the application of FIFO where there is transfer in, see the same example
used above
Step 1. Summary of physical units:
Beg. WiP Inv. 5,000 Units
Transferred In 20,000 Units
To be Account for 25,000 Units
Step 2. Computing Equivalent units:
Transferred
Total In costs DM CC
Beg. WiP 5,000 -- 5,000 2,000
Started and completed 16,000 16,000 16,000 16,000
WiP Ending 4000 4000 --- 1,200
Accounted for Equivalent units 25,000 20,000 21,000 19,200
Or

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Equivalent units using FIFO method can be computed by deducting equivalent units
in the beg inventory from the equivalent units computed under weighted average
method as follows:

Transferred
Total In costs DM CC
Equivalent units (Weighted) 25,000 21,000 22,200
Less: Beg. WiP, Equivalent units 5,000 -- 3,000
Equivalent units (FIFO) 20,000 21,000 19,200
Transferred
Total In costs DM CC
Beg. WiP Br. 25,000
Costs Added 165,500 104000 23100 38400
Divides by Equivalent units ÷ 20,000 ÷ 21000 ÷ 19200

Step 4. Equivalent unit cost 52 Br.11 Br. 2

Step 5. Application of costs:

Costs Transferred out:
Beg. WiP - Br. 25000
Costs Added:
Material 55000 5000(11)
CC 4000 2000(2)
Total From beg. WiP Br 84000
Started: Completed 1040000 16000 (….)
Total costs tran. Out 1,124000
WiP. Ending
Transferred In 208,000 4000(.52)
DM --- 0(.)
CC 2400

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Total WiP .Ending 210,400 1200(2)
Total Accounted for

The Journal entries to record the costs transferred out from forming Dep’t to
finishing and from finishing Department to finished goods inventory are shown
below.
Work – in process – finishing – XX
Work – in- process – forming – XX
To record costs trans. Form
Forming Dep’t to finishing Dep’t XX
Finished goods Inv.-------------- XX
(To record costs transferred from finishing Dep’t to finished Goods

Check your progress

i) Why should the accountant distinguish between
transferred – in costs and additional direct materials costs for a particular
department?
ii) What is the major accounting difference between
weighted average and first – in, first out methods with transferred in costs?

10.7 SUMMARY

Process costing system is used to determine the cost of a product when masses of
identical or similar units are produced. Unit costs are computed by dividing the total
cost of a department or a process by the units produced in a given period. There are
five step in process costing used determine the cost of the product. The last three
steps differ depending on the product costing Inventory costing method used – FIFO
or weighted average. The weighted average methods compute units’ costs by
dividing total cost to date by the total equivalent units to date and assign the total
costs using the equivalent unit costs to units completed and to units in the ending
work in process inventory. The first in first out method computes unit cost based on

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current costs only. It assigns costs of the beg WiP inventory only to those goods that
are completed first and the current period costs to the goods which completed next
and to those units in the ending work in process inventory.

The weighted average process costing method compute transferred – in costs per
unit by focusing on total transferred – in costs and total equivalent from units
completed to date. And assign this average cost to units completed and to units in
the ending work in process inventory. The FIFO process costing method assigns
transferred in costs in beginning work in process inventory to units completed, and
the costs transferred in during the current period first to complete beginning work –
in process units, then to start and complete new units, and finally to units in ending
work – in process inventory.

10.8 ANSWER TO CHECK YOUR PROGRESS

i) D ii) b iii) Cement, chemical, floor mills

iv) The journal entries in process costing system are similar to entries in a job –
costing system; there is a separate work in process account for each department.

10.9 MODEL EXAMINATION QUESTIONS

A. Short answer questions.

1. Define process costing.
2. List the five ken steps in process costing.
3. Name the three inventory methods.
4. Why should accountants distinguish between transferred – in costs and
additional?
Direct materials costs for a particular department?
5. Describe the distinctive characteristics of FIFO computations in assigning
costs to
Units completed and to units in the ending work – in process inventory.

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B) Multiple choice questions.
(1) The FIFO Method of process costing assigned the costs of the beginning
work – in
– Process inventory to:
A) To the units started & Completed in the current period first
B) To the first units completed
C) To the units in the ending work – in process inventory
D) To all units uniformly
(2) A derived amount of output units that takes the quantify of each input in
units completed or in work in process and or in work in process and converts
into the amount of completed out put units that could be made with that
quantify of input is:
a) Completed units
b) Equivalent units.
c) Work – in process, ending
d) Work – in process, beginning.
(3) When spiraled units have a disposal valve, the net cost of spoilage is
computed by
Deducting the disposal value from.
a) The costs of completed goods.
b) The costs of spoiled goods accumulated to the inspection point.
c) The costs of goods in the ending work – in process.
d) All of the above.
(4) If the normal spoilage is defected at 100% completed in the production
cycle, its costs are allocated only to:
a) Good units to units in
b) The ending inventory
c) To all units that started
d) None of the above.

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 (5) Unacceptable units which are discarded or sold at a reduced price are
a) Rework
b) Spoilage
c) Scrap
d) All of the above
C) Work out question
F asica company produces complex plastic rear lamps for cars using an injection
molding process. Direct materials are added at the start of the process.
Conversion costs are added evenly during the process. Spoiled units are defected
upon inspection at the end of the process and are disposed of at zero net disposal
price Assume normal spoilage is 15% of the good output produced. The
following information about actual costs for April 2002 is given below.
Equivalent units
Physical Direct
Conversion
Flow of production units Materials Costs
Work – in process April 1. 15000 15000 9000
Started during April 2002. 25000
Good units completed & transferred
As during April 20,000 20,000
20,000
Normal and Abnormal spoilage 4,000 4,000
4,000
Work – in process, April 30 16,000 16,000
12,000
Total costs for April 2002:
Work –in process, beginning
Direct materials Br. 120,000
Conversion costs. 90000 Br. 210,000
Direct materials added during April 210,000

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 Cano –cost added during April 291,600

Required
(1) Calculate the cost per equivalent units for direct materials and conversion
costs using FIFO method.
(2) Summarize total costs to account for, and assign these costs to units
completed and transferee out (including normal spoilage) to abnormal
spoilage, and to units in ending work – in process using FIFO Method.
(3) What is the cost of good units completed and transferred out using FIFO
method?

10.10 GLOSSARY

1. Equivalent units: - are output interims of completed units.

2. FIFO - Method of inventory that charges earliest costs to goods Completed and
recent costs to the units in the ending Work in process inventory.
3. Transferred in costs - costs of previous department.
4. Weighted Average Method - Method of Inventory that charges uniform costs to
goods Completed and to goods in the ending work
– in process Inventory.

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