Chapter-Three

Part II: Process costing

• Process costing: a product costing system that accumulates costs according to processes or
departments. A processing department is any location in the organization where work is performed
on a product and where materials, labor, and overhead costs are added to the product. Processing
departments should also have two other features. First, the activity performed in the processing
department should be essentially the same for all units that pass through the department. Second, the
output of the department should be homogeneous.

• Accumulated costs are spread over output of the period

• Used when outputs are standardized/ homogeneous

• Firms that produce homogeneous output in batch or continuous production processes can use process
costing eg. Cement, Beer factories, steel, sugar etc

Job-order Vs Process costing

No Basis Job- order Process
1. Based on the flow of There is no uniformity in the flow Uniform flow of productions
production production
2. Based on cost object. The focal point of a job order cost The focus of a process cost system
system is the job. is the cost center to which costs are
assigned.
3. Based on the nature of Many different products may be A single homogenous product is
product produced in a single period. produced on a continuous basis over
a long period of time.
4. Based on cost Costs are accumulated by Costs are accumulated by
accumulation individual job. department
5. Based on source document The job-cost sheet is the key The department production
document. report is the key document in
process costing.
6. Based on unit cost Job-order costing systems compute Process costing systems compute
determinations unit costs by job. unit costs by department.

7. Profit/ loss is determined job wise Profit/ loss is determined

Based on profit/loss department wise
determinations

Similarities between job-order and process costing: Job-order and process costing systems share some
characteristics:
a. Both systems have the same basic purpose—to assign material, labor, and overhead cost to
products.(ascertainment)
b. Both systems use the same basic manufacturing accounts: Manufacturing Overhead, Raw
Materials, Work In Process, and Finished Goods.
c. The flow of costs through the manufacturing accounts is basically the same.

Output measurement in process costing

In order to calculate the average cost per unit, the total number of units must be determined. Partially
completed units pose a difficulty that is overcome using the concept of equivalent units.

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Equivalent units: Is the number of the same or similar complete units that could have been produced
given the amount of work actually performed on units completed and partially complete units.
• An expression of partially completed units in terms of fully completed units. The formula for
computing equivalent units is:

• Equivalent units= Number of partially completed units* Percentage completion

• Example: 2 units 50% complete = 1 unit fully complete

Approaches in process costing system

 Account for the physical units

 Calculate equivalent units for each manufacturing cost element (FIFO or

weighted-average method)

 Determine total costs for each manufacturing cost element (FIFO or

weighted-average method)

 Compute cost per equivalent unit for each manufacturing cost element

 Assign total manufacturing costs to units completed and ending WIP

Inventory

To illustrate, let consider the case of Global Defense Inc., manufacturing thousands of components for
missiles and military equipment. These components are assembled in the Assembly Department. Upon
completion, the units are immediately transferred to the Testing Department. We will focus on the
Assembly Department Process for one of these components, DG-19. Every effort is made to ensure that
all DG-19 units are identical and meet a set of demanding performance specifications. The process-
costing system for DG-19 in the assembly Department has a single direct –cost category (direct material)
and a single indirect-cost category (conversion costs). Conversion costs are all manufacturing labor,
indirect material, energy, plant depreciation, and so on. Direct material is added at the beginning of the
process in Assembly. Conversion costs are added evenly during assembly. The following graph
summarizes these facts:

Conversion costs
added evenly during
process

Assembly
Transfer Testing
Department
Department

Direct materials
added at the beginning
of the process

Process costing system separate costs into cost categories according to the timing of when costs are
introduced into the process. Often, as in the case of Global Defense example ,only two cost
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classifications, direct material and conversion costs, are necessary to assign costs to products. These is
because, all direct materials are added to the process at one time and all conversion costs are generally
added to the process uniformly through time. If however, two different direct materials are added to the
process at different times, two different direct material categories would be needed to assign these costs to
products. Similarly, if manufacturing labor is added to the process at a time that is different from other
conversion costs, an additional cost category (direct manufacturing labor costs) would be needed to
separately assign these costs to products.
To illustrate, we will use the production of the DG-19 component in the Assembly Department to
illustrate process costing in three cases:
 Case-1: Process costing with zero beginning and zero ending work-in-process inventory of
DG-19, that is, all units are started and fully completed by the end of the accounting period.
This case presents the most basic concepts of process costing and illustrates the key feature of
averaging of costs.
 Caes-2: Process costing with zero beginning work-in-process inventories but some ending
work-in-process inventory of DG-19,that is, some units of DG-19 started during the
accounting period are incomplete at the end of the period. This case builds on the basics and
introduces the concepts of equivalent units.
 Case-3: Process costing with both beginning and some ending work-in-process inventory of
DG-19 units. This case adds detail and describes the effect of weighted-average and first –in-
first-out (FIFO) cost flow assumptions on cost of units completed and cost of work-in-
process inventory.

Case-1: Process costing with zero beginning and zero ending work-in-process inventories

On January 1, 2001, there was no beginning inventory of DG-19 units in the Assembly Departments.
During January 2001, Global Defense started, complete assembly, and transferred out to the Testing
Department, 400 DG-19 units
Data for Assembly department for January are:

Physical units for January 2001

Work-in-process beginning inventory (January-1) 0 units

Started during January 400 units
Completed and transferred out during January 400 units
Work in process, ending inventory January-31 0 units

Total costs for January 2001

Direct material costs added during January $32,000
Conversion costs added during January 24,000
Total Assembly Department costs added during January $56,000
Global Defense records direct materials and conversion costs in the Assembly Department as these costs
are incurred. By averaging, the assembly costs per unit of DG-19 are $56,000 ÷ 400 units = $140,
itemized as follows:

Direct material costs per units ($32,000 ÷ 400 units) $80

Conversion costs per units ($24,000 ÷400) 60
Assembly Department costs per unit $140
This case shows that, in a process-costing system, unit costs can be averaged by dividing total costs in a
given accounting period by total units produced in that period. Because, each unit is identical, we assume
all units receive the same amount of direct material and conversion costs. This approach can be used by
any company that produces a homogeneous product or service but has no incomplete units when each
accounting period ends. This situation frequently occurs in service-sector organizations.

Case-2: Process costing with zero beginning but some ending work-in-process inventory

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In February 2001, Global Defense placed another 400-units of DG-19 into production. Units placed into
production in January 2001 were completely assembled i.e. there is no beginning inventory of partially
completed units in the Assembly Department on February 1, 2001. Customer delays in placing orders for
DG-19 prevent the complete assembly of all units started in February. Only 175-units are completed and
transferred out to the Testing Department.

Data for the Assembly Department for February 2001 are:

Physical Units for February 2001

Work –in-process, beginning inventory (February-1) 0 units

Started during February 400 units
Completed and transferred out 175 units
Work in process, ending inventory (February 28) 225 units
The 225 units partially assembled units as of February 28, 2001, are fully processed with respect to direct
materials. This is 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 complete the DG-19 units still in the process, an
Assembly supervisor estimates that the partially assembled units, are on average,60% complete as to
conversion costs.

Total costs for February 2001

Direct materials costs added during February $32,000

Conversion costs added during February 18,600
Total Assembly Department costs added during February $50,600

The accuracy of the completion percentages depends on the care and skill of the estimator and the nature
of the process. Estimating the degree of completion is usually easier for direct materials than it is for
conversion costs. This is because, the materials for partially completed units can be measured more
easily. In contrast, the conversion sequence usually consists of a number of basic operations for a
specified number of hours, days or weeks, for various steps in assembly, testing, and so forth. Thus, the
degree of completion for conversion costs depends on what proportion of the total effort needed to
complete one unit or both of production has been devoted to units still in process. This estimate is more
difficult to make because of the difficulties in estimating conversion cost completion percentages,
department supervisors and line managers –individual most familiar with the process often make these
estimates.

The key points to note in case-2 are that a partially assembled unit is not the same as a fully assembled
unit. Whenever there are some fully assembled and some partially assembled units, as to how should
Global Defense calculate (1) the cost of fully assembled units in February 2001, and (2) the cost of the
partially assembled units still in process at the end of February 2001 is a very important points to be
noticed here.

Global Defense calculates these costs by using the following five steps:
 Step-1: Summarize the flow of physical units of outputs
 Step-2: Compute output in terms of equivalent units
 Step-3: Compute equivalent unit costs
 Step-4: Summarize total costs to account for
 Step-5: Assign total costs to units completed and to units in ending work in process.

Physical units and Equivalent units (Step-1 and 2)

Step-1: This steps tracks the physical units of output. It identifies or shows from where the units come
from and where the units go. The physical units column of exhibit 7-1 below indicates:
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 i) 400 units are started during February 2001
ii) 175 units are completed and transferred out
iii) 225 units are remained in work-in-process inventory
Step-2: Focuses on how the output for February should be measured. The out put is 175 fully completed
units plus 225 units partially assembled units. Since all 400 physical units are not uniformly completed,
output in step-2 is computed in equivalent units, not in physical units. Equivalent units- is a derived
amount of output units that takes the quantity of each input (factor of production) in units completed or in
work in process, and converts it into the amount of completed output units that could be made with that
quantity of input. For example, if 50 physical units of a product in ending work-in-process inventory are
70% complete with respect to conversion costs, there are 35 (70% × 50) equivalent units of output for
conversion costs. That is, if all the conversion costs input in the 50-units in inventory were used to make
completed output units, the company would be able to make 35 completed units of output. Equivalent
units are calculated separately for each input (cost category).

EXHIBIT 7-1-Step-1 and 2: Summarizes output physical units and compute

Equivalent units
Assembly Department of Global Defense, Inc.., for February 2001.

(Step-1) (Step-2)
Physical Equivalent units
units
Direct Conversion
Flow of production materials costs

-Work-in-process, beginning 0
- Started during current period 400
-To account for 400
-Completed and transferred out
during current period 175 175 175
- Work-in-process ending * 225
225 × 100%;225 ×60% 225 135
- Account for 400
-Work done in current period only 400 310

*Degree of completion in this department: direct material, 100%; conversion costs, 60%.

When calculating equivalent units in step-2, focus on quantities. The dollar amounts should be
disregarded until after equivalent units are computed. In the Global Defense example:
i) All 400-physical units i.e. the 175 units fully assembled ones and the 225 partially
assembled ones are complete in terms of equivalent units of direct materials. This
is because; direct materials are added in the assembly Department at the initial
stage of the process. Exhibit 7-1 shows output as 400 equivalent units for direct
materials because all 400-units are fully complete with respect to direct materials.
ii) The 175 fully assembled units are completely processed with respect to
conversion costs. The partially assembled units in ending work in process are
60% complete (on average). Therefore, the conversion costs in the 225 partially
assembled units are equivalent to conversion costs in 135 (60% of 225) fully
assembled units. Hence, exhibit 7-1 shows output as 310 equivalent units with
respect to conversion costs i.e. 175 equivalent units assembled and transferred out
and 135 equivalent units ending work-in-process inventory.

Calculation of product costs (Step 3, 4 and 5)

Exhibit 7-2 shows steps 3, 4, and 5. Together, they are called the production cost worksheet.
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 Step-3 calculates equivalent-units costs by dividing direct material and conversion costs added during
February by the related quantity of equivalent units in ending work-in-process inventory. Here, the use of
equivalent unit in calculating unit costs can be seen by comparing conversion costs for the Month of
January and February 2001.Accordingly it is possible to observe that:
i) The total conversion costs of $18,600 for the 400 units worked on during February are less
than the conversion costs of $24,000 for the 400 units worked on in January. However,
the conversion costs to fully assemble a unit are $60 in both January and February.
ii) Total conversion costs are lower in February because fewer equivalent units of conversion
costs work were completed in February (310) than were in January (400). If however,
we had used physical units instead of equivalent units in the per unit calculation, we
would have erroneously concluded that conversion costs per unit declined from $60 in
January to $46.50 ($18,600÷400) in February. Such incorrect costing might prompted
companies to lower the selling price of their products inappropriately.
Step-4 in exhibit 7-2 summarizes total costs to account for. Because the beginning balance of the
work-in-process inventory is zero, total costs to account for (that is, total charges or debits to work-in-
process-Assembly) consists of the costs added during February –direct material of $32, 000, and
conversion costs of $18,600, for a total of $50,600.
Step-5 in exhibit 7-2 below assigns these costs to units completed and transferred out and to units still in
process at the end of February 2001.The key idea is to attach dollar amounts to the equivalent outputs
units for direct materials and conversion costs in (a) units completed and (b) ending work in process
calculated in exhibit 7-1, step-2.To do so, the equivalent output units for each input are multiplied by the
cost per equivalent unit calculated in step-3 of exhibit 7-2.

EXHIBIT 7-2

Steps 3, 4, and 5: Compute Equivalent-units costs, Summarize Total costs to Account for, and
Assign costs to units completed and to units in ending Work-in-process
Assembly Department of Global Defense, Inc., for February 2001.

Total Direct Conversion

Production costs materials costs

(Step-3) -Costs added during February $50,600 $32,000 $18,600

Divided by equivalent units
-Work done in current period
(exhibit 7-1) ÷ 400 ÷ 310
- Cost per equivalent ---------------------------- ----- $80 $60
(Step-4) -Total cost to account for $50,600

(Step-5) Assignment of costs

- Completed and transferred
out (175 units) ----------------- $24,500 ---------(175 a×$80) + (175a× $60)
- Work in process ending (225 units)
Direct materials 18,000 (225 b × $80)
Conversion costs 8,100 135b× $60
Total work in process 26,100
Total cost accounted for $50,600

a Equivalent units completed and transferred out from Exhibit 7-1

b Equivalent units in ending work in process from exhibit 7-1,step-2

Journal entries

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 Journal entries in process- costing systems are basically like those made in job-costing systems with
respect to direct materials and conversion costs. The main difference is that, in process costing, there is
often more than one Work-in-Process accounts, one for each process-in our example, Work in Process-
Assembly and Work in Process-Testing.

. Work in process- Testing 24,500

Work in Process-Assembly 24,500

To record cost of goods completed and transferred from assembly to testing

during February.

Case 3: Process costing with both some beginning and ending work-in-process inventory
At the beginning of March 2001, Global Defense had 225 partially assembled DG-19 units in the
Assembly Department. During March 2001, Global Defense placed another 275 units into production.
Data for the Assembly Department for March 2001 are:
Physical units for March 2001
Work in process, beginning inventory (march-1) 225 units
Direct materials (100% complete)
Conversion costs (60% complete)
Started during March 275 units
Completed and transferred out during March 400 units
Work in process, ending inventory (March 31) 100 units
Direct materials (100% complete)
Conversion costs (50% complete)
Total costs for March 2001
Work in process, beginning inventory
Direct material (225 equivalent units×$80 per units) $18,000
Conversion costs (135 equivalent units×$60 per units) 8,100 $26,100
Direct material costs added during March 19,800
Conversion costs added during March 16,380
Total costs to accounts for $62,280

We now have incomplete units in both beginning and ending work-in-process inventory to account for.
Our goal is to use the five steps we describes earlier to calculate
1) The costs of units completed and transferred out, and
2) The cost of ending work in process.
To assign costs to each of these categories, however, we need to choose an inventory cost-flow method.
We next describe the five-step approach to process costing using two alternative inventory cost-flow
methods-the weighted average method and the first-in-first-out method. The different assumption will
assign different amounts of costs to units completed and tounits in ending work in process.

WEIGHTED AVERAGE METHOD

The weighted average process costing method calculate-unit cost of the work done to date (regardless of
the period in which it was done) and assigns this cost to equivalent units completed and transferred out of
the process and to equivalent units in ending work-in-process inventory. The weighted –average cost is
the total of all costs entering thk8e Work in process account (regardless of whether it is from beginning
work in process or form work started during the period) divided by total equivalent units of work done to
date. We now describe the five-step procedure introduced in case-2 using weighted average method.

Step-1: Summarize the flow of physical units- exhibit 7-3 below indicates that:
i) 225-units are from beginning inventory From where
ii) 275 units are started during the current period they came

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 iii) 400 units are completed and transferred out ,and where they
iv) 100 units are in ending work in process inventory. went

Step-2: Compute output in terms of Equivalent units- as we can see from case-2 above that even
partially assembled units are completed in terms of direct materials because direct materials are
introduced at the beginning of the process. For conversion costs, the fully assembled physical units
transferred out are, of course, fully completed. The Assembly Department supervisor estimates the
partially assembled physical units in March 31 work in process to be 50% complete (on average).

The equivalent units columns in exhibit 7-3 below show the equivalent units of work done to date-
equivalent units completed and transferred out and equivalent units in ending work in process (500
equivalent units of direct materials and 450 equivalent units of conversion costs). Notice that the
equivalent units of work done to date also equal the sum of the equivalent units in beginning inventory
(work done in the previous period) and the equivalent units of work done in the current period, because:

Equivalent units Equivalent units Equivalent units Equivalent

in beginning + of work done = completed and + units in
Work in process current period transferred out ending work
in current period in process
The equivalent units calculation in the weighted average method is only concerned with total equivalent
units of work done to date regardless of (1) whether the work was done during the previous period and is
part of beginning work in process, or (2)whether it was done during the current period. That is the
weighted average method merges equivalent units in beginning inventory (work done before March) with
equivalent units of work done in current period. Thus, the stage of completion of the current period
beginning work in process percentage is irrelevant and not used in the computation.
Exhibit 7-3

Steps 1 and 2: Summarize Output in physical units and compare Equivalent units Weighted-
Average Method of process costing: Assembly Department of Global Defense, inc., for March 2001

(Step-1 (Step-2)
Physical unit’s Equivalent units
(Given)

Direct Conversion
Flow of Production Materials Costs

-Work in process, beginning 225

- Started during current period 275
-Total accounted for 500

- Completed and transferred out

during current period 400 400 400

- Work-in-process, ending a 100

(100×100%; 100×50%) 100 50

- Accounted for 500

- Work done to date 500 450

a
Degree of completion in this department direct matials,100%; Conversion costs, 50%

Step-3: Compute Equivalent-units costs- Exhibit 7-4 , step-3, shows the computation of equivalent –
units costs separately for direct materials and conversion costs. The weighted-average cost per equivalent
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unit is obtained by dividing the sum of costs for beginning work in process and costs for work done in the
current period by total equivalent units of work done to date. When calculating the weighted-average
conversion costs per unit in exhibit 7-4, for example, we divide total conversion costs, $24,480
(beginning work in process, $8,100, plus work done in current period, ($16,380), by total equivalent
units, 450 (equivalent units of conversion costs in beginning work in process and in work done in current
period), to get a weighted-average cost per equivalent unit of $54.40
i.e. [($8,100 + $16,380) ÷ 450 units] = $54.40

Step-4: Summarize Total costs to Account for- The total costs to account for in March 2001 are
described in the example data on page-14 –beginning work in process, $26,100 (direct materials, $18,000
and conversion cost,$8,100) plus $36,180 (direct materials costs added during March, $19,800, and
conversion costs, $16,380). The total of these costs is $62,280.

Step-5: Assign costs to units completed and to units in ending work in process - The key point in this
step is to cost all work done to date i.e.
1) The cost of units completed and transferred out of the process ,and
2) The cost of ending work in process.
Step-5 in exhibit7-4 takes the equivalent units completed and transferred out and equivalent units in
ending work in process calculated in exhibit7-3, step-2 and attaches dollar amounts to them. These dollar
amounts are the weighted-average costs per equivalent unit for direct material and conversion costs
calculated in step-3. For example, note that the total cost of the 100 physical units in ending work in
process consists of:
Direct materials:
100 equivalent units ×weighted-average cost per equivalent unit of $75.60 = $7,560
Conversion costs:
50-equivalent units × weighed-average cost per equivalent unit of $54.40 = 2,720
Total costs of ending work in process ---------------------------------------------- $10,280

The following table summarizes the total costs to account for and the $62,280 accounted for in exhibit 7-5
below.
The arrow indicate that the costs of units completed and transferred out and in ending work in process in
process are calculated using average total costs obtained after merging costs of beginning costs of
beginning work in process and costs added in the current period.
Costs accounted for
Costs to Account for calculated at weighed-average cost

Beginning work in process $26,100 Completed and transferred out $52,000

Costs added in current period 36,180 Ending work in process 10,280
Total costs to account for $62,280 Total costs accounted for $62,280

Exhibit 7-4
Steps3, 4,and 5: Compute Equivalent-unit costs, summarizes total costs to Account for, and assign
costs to units completed and to units in Ending Work in process Weighted-average method of
process costing
Total
Production Direct Conversion
Costs Materials costs

Step-3:- Work in process, beginning

(given page-7) ---------------$26,100 --------------------$18,000----------$8,100
-Costs added in current period
(given on page-14)---------36,180 -------------------19,800 -----------16,380
- Costs incurred to date $37,180 $24,480
- Divided by equivalent unit
work done to date (exhibit 7-4) ÷500 ÷450
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 -Costs per equivalent unit of work
to date -------------------------------- $75.60 $54.40

(Step-4) Total costs to accounts for $62,280

(Step-5)Assignment of costs:
-Completed and transferred out
(400 units) 52,000 (400 a × $75.60) + (400a ×$54.40)
- Work in process, ending (100 units)
 Direct materials 7,560 100b ×$75.60
 Conversion costs 2,720 50b ×$54.40
Total work in process 10,280
Total costs accounted for $62,280
a
Equivalent units completed and transferred out from exhibit 7-3, step-2.
b
Equivalent units in ending work in process exhibit 7-3,step2.

Using dollar amounts from exhibit 7-4, summary journal entries under the weighted –average method for
the month of March at Global Defense, Inc., are:
1. Work in process-Assembly 19,800
Accounts payable control 19,800
To record direct materials purchased and used in production during March.
2. Work in Process-Assembly 16,360
Various accounts 16,380
To record assembly department conversion costs for March; examples include energy,
manufacturing supplies, all manufacturing labor, and plant depreciation
3. Work in process-Testing 52,000
Work in process-Assembly 52,000

To record cost of goods completed and transferred from Assembly to Testing during March.

The key T-account, Work in process-Assembly, under the weighted-average method would
shows the following:
Work-in process-Assembly

Beginning inventory, March-1, 26,100 iii) Completed and transferred out

i) Direct material 19,800 to work in process –Testing 52,000
ii) Conversion costs 16,380

Ending inventory, March-31 10,280

FIRST-IN, FIRST-OUT (FIFO) METHOD

In contrast to the weighed-average method, the first-in, first-out (FIFO) process costing method assigns
the costs of the previous period’s equivalent units in beginning work in process inventory to the first units
completed ad transferred out of the process, and assign the costs of equivalent units worked on during the
current period first to complete beginning inventory, then to start and complete new units, and finally to
units in ending work-in-process inventory. This method assumes that the earliest equivalent units in the
work in process-Assembly accounts are completed.
A distinctive feature of the FIFO process-costing method is that work done on beginning inventory before
the current period is kept separate from work done in the current period. Costs incurred in the current
period and units produced in the current period are used to calculate costs per equivalent unit of work
done in the current period. In contrast, equivalent-unit and costs per equivalent unit calculation in the
weighted average method merge the units and costs in beginning inventory with units and costs of work
done in the current period.
We now describe the five-step produced in case-2 using the FIFO method
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Step-1: Summarize the flow of physical units-exhibit 7-5, step, traces the flow of physical units of
production. The following observation help explains the physical units calculation
 The first physical units assumed to be completed and transferred out during the
period are the 225 units from the beginning work-in-process inventory.
 Of the 275 physical units started, 175 are assumed to be completed. Recall from
the March data given on page-14 that 400 physical units were completed during
March. FIFO method assumes that the first 225 of these units were from beginning
inventory; thus 175 (400-225) physical units must have been started and completed
during March.
 Ending work-in-process inventory consists of 100 physical units-the 275 physical
units started minus the 175 of these physical units completed.
 Note that the physical units “to account for” equal the physical units “accounted
for” (500 -units)
Step-2: Compute output in terms of equivalent units- Exhibit7-5 also presents the computations for
step-2 under the FIFO method. The equivalent-units calculated for each cost category focus on the
equivalent units of work done in the current period (March) only.
Under FIFO method the work done in the current period is assumed to first complete the 225 units in
beginning work in process. The equivalent units of work done in March on the beginning work-in-process
inventory are computed by multiplying the 225 physical units by the percentage of work remaining to be
done to complete these units i.e. 0% for direct material, because the beginning work in process is 100%
complete with respect to direct materials, and 40% for conversion costs, because the beginning work in
process is 60% complete with respect to conversion costs. The results are 0 ( 0%×225) equivalent units
of work for direct materials and 90 (40% ×225) equivalent units or work for conversion costs.
Next, the work done in the current period is assumed to start and completes the next 175 units. The
equivalent units of work done on the 175 physical units started and completed are computed by
multiplying 175 units by 100% for both direct materials and conversion costs, because all work on these
units is done in the current period.
Finally, the work done in the current period is assumed to start but leave incomplete the final 100 units as
ending work in process. The equivalent units of work done on the 100 units of ending work in process are
calculated by multiplying 100 physical units by 100% for direct materials (because all direct materials
have been added for these units in the current period) and 50% for conversion costs (because 50% of
conversion costs work has been done on these units in the current period)
EXHIBIT 7-5:
Steps 1 and 2:Summarize output in physical units and computed Equivalent FIFO method of
process costing –Assembly department of Global Defense,Inc., for March 2001
(Step-1) Step-2
Physical Equivalent units
units Direct materials Conversions costs
Flow of production
-Work in process, beginning (page-14) 225 ( work done before current period)
-Started during current period (page-14) 275
-To account for 500
- Completed and transferred out
during current period:
-Form beginning work in processa 225
(225× (100%-100%); 225× (100%-60%) 0 90
b
-Started and completed 175
(175×100%; 175×100% 175 175
-Work in process,endingc (page-14) 100
100×100%; 100×50% 100 50
-Accounted for 500
-Work done in current period only 275 315
a
Degree of completion in this department: direct materials,100%;conversioncosts,60%

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b
400 Physical units completed and transferred out minus 225 physical units completed and transferred out
form beginning work-in-process inventory.
c
Degree of completion in this department: direct materials,100%;conversion costs,50%
Step-3: Compute equivalent-units costs – Exhibit 7-6 shows the step-3 computation of equivalent-units
costs for work done in the current period only for direct materials and conversion costs. For example, we
divide current period conversion costs of $16,380 by current –period equivalent units for conversion costs
of 315 to obtain cost per equivalent unit of $52.
Step-4: Summarize total cost to account for-The total production costs column in exhibit 7-6 presents
step-4 and summarize the total costs to account for in March 2001 (beginning work in process and costs
added in the current period)of $62,280, as described in the example data (page-14)
Step-5: Assign costs to units completed and to units in ending work in process – Finally, exhibit 7-6
shows the step-5 assignment of costs under the FIFO method. The cost of work done in the current period
are first assigned to the additional work done to complete the beginning work in process, then to the work
done on units started and completed during the current period, and finally to the ending work in process.
The easiest way to follow step 5 is to take each of the equivalent units calculated in exhibit
7-5, step2, and attach dollar amounts to them (using the cost-per-equivalent-units calculations in step-3).
The goal is to determine the total cost of all units completed from beginning inventory and from work
started and completed in the current period, and the costs of ending work in process done in the current
period.
EXHIBIT 7-6
Step 3, 4 and 5: Compute equivalent-unit costs, summarize total costs to Account for, and Assign costs to
units completed and to units in ending work in process-FIFO-method of process costing- Assembly
department of Global Defense, Inc.,for March 2001.
Total Direct Conversion
Production costs materials costs
-Work in process, beginning ( page-7) $ 26,100 ( Costs of work done before
Current period)
(Step-3)Costs added in current period (pg-7) 36,180 $19,800 $16,380
-Divided by equivalent units of work done
in current period (exhibit7-6) ÷275 ÷315
-Costs per equivalent unit of work done in current period $72 $52
(Step-4) Total costs to account for $62,280
(Step-5) Assignment of costs:
-Completed and transferred out (400 units):
 Work in process, beginning (225 units) $26,100
 Direct materials added in current period 0 0×$72
 Conversion costs added in current period 4,680 90×$52
 Total from beginning inventory 30,780
 Started and completed (175 units) 21,700 (175b×$175) (175b×$52)
 Total costs of units completed and
transferred out 52,480
 Work in process, ending (100 units):
Direct materials 7,200 100×$72
Conversion costs 2,600 50c×$52
Total work in process, ending 9,800
Total costs accounted for $62,280
a
Equivalent units used to complete beginning work in process from exhibit7-5, step-2
b
Equivalent units started and completed from exhibit 7-5,step 2.
c
Equivalent units in ending work in process exhibit 7-5, step2
NB. Notice that the 400 completed units are of two types. These are:
i) 225 units come from beginning inventory, and 175 units are started and completed
during March. The FIFO method starts by assigning the costs of the beginning work-in-
process inventory of $26,100 to the first units completed and transferred out. This
$26,100 is the cost of the 225 equivalent units of direct material and 135 equivalent
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 units of conversion costs of the 225 equivalent units of directs materials and 135
equivalent units of conversion costs that comprise beginning inventory. The work that
generated these costs was done in February, so these units are costed (see data on costs
[(225 ×$80) + (135×60) = $26,100]. As we saw in step-2, an additional 90 equivalent
units of conversion costs are needed to complete these units in the current period.
ii) The current period conversion costs per equivalent units is $52, so $4,680 (90×$52) of
additional costs are needed to complete the beginning inventory. The total production
costs for the units started and completed in the current period consist of 175 equivalent
units of direct materials and 175 equivalent units of conversion costs. These units are
costed at the cost per equivalent unit in the current period,(direct materials,$72 and
conversion costs,$52)for a total production cost of $21,700.
iii) Under FIFO method the ending work-in-process inventory comes from units that were
started but not fully completed during the current period . The total cost of the 100
partially assembled physical units in ending work in process consists of :
Direct materials:
-100 equivalent units × cost per equivalent unit in March of $72 $7,200
Conversion costs
-50 equivalent units × cost per equivalent units in March of $52 2,600
Total costs of work in process on March 31 $9,800
The following table summarizes the total costs to account for and the costs accounted for of $62,280 in
exhibit 7-6. Notice how under the FIFO method, the layers of beginning work in process and costs added
in the current period are kept separate. The arrows indicate where the costs in each layer go (that is, to
units completed and transferred out or to ending work in process). Be sure to include the costs of
beginning work in process ($26,100) when calculating the costs of units completed from beginning
inventory.
Costs to account for Costs accounted for calculated on a FIFO bases

Beginning work in process $26,100 Completed and transferred out:

Costs added in current period 36,180 Beginning work in process $26,100
Used to complete work beginning
work in process 4,680
Started and completed 21,700
Ending word in process 9,800
Total costs accounted for $62,280 Total costs accounted for $62,280
NB. The journal entries under the FIFO method parallel the journal entries under the weighted –average
method. The only difference is that the entry to record under cost of goods completed and transferred out
would be for $52,480 under the FIFO method instead of for $52,000 under the weighted-average method.

Comparison of weighted –average and FIFO methods

The following table summarizes the costs assigned to units completed and to units still in process under
the weighted-average and FIFO process-costing methods for our example:

Weighted average FIFO

(from exhibit 7-4) (from exhibit 7-6) Difference
-Costs of units completed
and transferred out $52,000 $52,480 +$480
-Work-in-process, ending 10,280 9,800 - 480
-Total costs accounted for $62,280 $62,280

From the above summary it can be seen that the weighted –average ending inventory is higher than the
FIFO ending inventory by $480, or 4.9% ($480÷$9,800). This is a significant difference when aggregated
over the many thousands of products that Global Defense makes. The weighted-average method in our
example also results in lower cost of goods sold and hence higher operating income and higher income
taxes than does the FIFO method. Differences in equivalent-unit costs of beginning inventory and work
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done during the current period, account for the difference in weighted-average and FIFO costs. Recall
from the data on page-14 that direct materials costs per equivalent units in beginning work-in –process
inventory is $80, and conversion cost per equivalent unit in beginning work-in-process inventory is $60..
These costs are greater than the $72 direct materials and $52 conversion costs per equivalent unit of work
done during the current period. This reduction could be due to a decline in the prices of direct
materials and conversion cost inputs or could be a result of Global Defense becoming more
efficient.

For Assembly department, FIFO assumes that all the higher-cost units from the previous period in
beginning work in process are the first to be completed and transferred out of the process, and ending
work-in-process consist of only the lower-cost current-period units. The weighted-average method,
however, smoothes out cost per equivalent unit by assuming that more of the lower-cost units are
completed and transferred out, and some of the higher-cost units are placed in ending work in process.
Hence, in this example, the weighted-average method results in a lower cost of units completed and
transferred out and a higher ending work-in-process inventory relative to FIFO.

Cost of units completed and hence operating income can differ materially between the weighted-average
and FIFO methods when (1) the direct materials or conversion costs per unit vary significantly from
period to period, and (2) the physical inventory levels of work in process are large in relation to the total
number of units transferred out of the process. Thus, as companies move towards long-term procurement
contract that reduce difference in unit costs from period to period, and reduce inventory levels, the
difference in cost of units completed under the weighted-average and FIFO method will decrease.

Managers need information from process-costing systems to aid them in the pricing and product mix
decisions and to provide them with feedback about their performance. The major advantage of FIFO is
that it provides managers with information about changes in the costs per unit from one period to the next.
Managers can use this information to evaluate their performance in the current period compared to a
benchmark or compared to their performance in the previous period. By focusing on work done and the
costs of work done during the current period, the FIFO method provide useful information for these
planning and control purposes. The weighed-average method merges unit costs from different periods and
so obscures period-to-period comparisons. The major advantages of the weighted –average method
however are its computational simplicity and its reporting of a more representative average unit cost when
input prices fluctuate markedly from month to month.

Spoilage, reworked units and scrap

 Spoilage is units of production – whether fully or partially completed - that do not meet the
standards required by customers for good unit and that are discarded as waste or sold for reduced
prices.
 Rework (Defective units) is units of production that do not meet the standards required by
customers for finished units that are subsequently repaired and sold as acceptable finished units.
Spoiled units can be reworked to meet standards, but only at a considerable cost know as
rework costs.
 Scrap – residual material that results from manufacturing a product. Scrap has low total sales
value compared with the total sales value of the product. Note that while scrap is limited to a loss
of materials, spoilage involves a loss of labor and overhead as well as materials.

Types of Spoilage
1. Normal spoilage
2. Abnormal Spoilage

Normal Spoilage
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  It is spoilage inherent in a particular production process that arises even under efficient operating
conditions.
 It is acceptable (unavoidable), planned for and can be estimated as a percentage of total good
units that pass the inspection point of the operations.
 Costs of normal spoilage are typically included as a component of the costs of good units
manufactured because good units cannot be made without also making some units that are
spoiled (i.e., normal spoilage is a product cost)

Abnormal Spoilage
 Spoilage in excess of what is considered normal for a particular production process is called
abnormal spoilage. Abnormal spoilage, unlike normal spoilage, cannot be anticipated /estimated.
 It is not inherent in a particular production process and would not arise under efficient operating
conditions. They arise for unusual or abnormal reasons such as: machine breakdown and
operator errors, when production line equipment is not adjusted properly, when inferior raw
materials are purchased, or by fire, explosion, or other unusual events.
 Usually regarded as avoidable and controllable – by identifying the reasons for machine
breakdowns and accidents and the like, and taking a remedial action, giving proper training to line
operations and other plant personnel
 Not inventoriable (not included in the cost of good units) rather they are reported as “loss from
abnormal spoilage” account.
Process Costing & Spoilage

 The cost of spoiled units depends on when the units are removed from the production process
rather than on when spoilage actually occurs, i.e. cost of spoiled units is assumed to be all costs
incurred on them prior to inspection point.
 An inspection point is the stage of the production cycle at which products are examined to
determine whether they are acceptable or unacceptable units.
 Spoilage is typically assumed to occur at the stage or completion where inspection takes place.

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