Process Costing: Cornerstones of Managerial Accounting, 4e

Chapter 6:
Process Costing
Cornerstones of Managerial Accounting, 4e
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Learning Objectives
1. Describe the basic characteristics and cost flows associated
with process manufacturing.
2. Define equivalent units and explain their role in process
costing. Explain the differences between the weighted
average method and the FIFO method of accounting for
process costs.
3. Prepare a departmental production report using the
weighted average method.
4. Explain how nonuniform inputs and multiple processing
departments affect process costing.
5. (Appendix 6A) Prepare a departmental production report
using the FIFO method.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
1 Characteristics of Process
Manufacturing
►Since each product within a product line
passing through the processes would receive
similar ‘‘doses’’ of materials, labor, and
overhead, costs are accumulated by process.
►Process costing works well whenever
relatively homogeneous products pass
through a series of processes and receive
similar amounts of manufacturing costs.
1 Types of Processes
► Sequential processing requires that units pass through one

process before they can be worked on in the next process in
the sequence.
► Parallel processing is another processing pattern that

requires two or more sequential processes to produce a
finished good.
1 Types of Processes
(continued)
► Partially completed units (e.g., two subcomponents) can be

worked on simultaneously in different processes and then
brought together in a final process for completion.
1 What’s In Common?
►Regardless of which processing pattern exists within
a firm, all units produced share a common property.
►Units are homogeneous and subjected to the same
operations for a given process and each unit produced in a
period should receive the same unit cost.
►Understanding how unit costs are computed
requires an understanding of the manufacturing cost
flows that take place in a process-costing firm.
1 How Costs Flow through the
Accounts in Process Costing
► The manufacturing cost flows for a process-costing system are
generally the same as those for a job-order system.
► As raw materials are purchased, the cost of these materials flows
into a raw materials inventory account. Similarly, raw materials,
direct labor, and applied overhead costs flow into a work-in-process
(WIP) account.
► When goods are completed, the cost of the completed goods is
transferred from WIP to the finished goods account.
► Finally, as goods are sold, the cost of the finished goods is
transferred to the cost of goods sold account.
► The journal entries generally parallel those described in a job-order
costing system.
How Costs Flow through the
1
Accounts in Process Costing
(continued)
► Although job-order and process cost flows are generally similar, some differences
exist.
► In process costing, each producing department has its own WIP account. As goods
are completed in one department, they are transferred to the next department.
► The costs attached to the goods transferred out are also transferred to the next
department.
Cornerstone 6-1
1 Calculating Cost Flows
without Work in Process
Information:
► Suppose that Healthblend decides to produce 2,000 bottles
of multivitamins with the following costs (there is no
beginning or ending work-in-process for each department):
Required:
1. Calculate the costs transferred out of each department.
2. Prepare journal entries that reflect these cost transfers.
Cornerstone 6-1
1 Calculating Cost Flows
without Work in Process (continued)
Solution:
1 Accumulating Costs in the
Production Report
► In process costing, costs are accumulated by department for a
period of time.
► The production report is the document that summarizes the
manufacturing activity that takes place in a process
department for a given period of time.
► A production report contains information on costs transferred
in from prior departments as well as costs
added in the department such as direct
materials, direct labor, and overhead; ^^^^^^^^
^^^^^^^^
similar to the job-order cost sheet, ^^^^^^^^
it is subsidiary to the WIP account. ^^^^^^^^
1 Accumulating Costs in
the Production Report (continued)
► A production report is divided into the following sections

and subdivisions: Unit information section: The
unit information section has two Unit
major subdivisions: ^^^^^^^^
• units to account for Cost
• units accounted for ^^^^^^^^
Cost information section: The
cost information section has two
major subdivisions:
• costs to account for
• costs accounted for
► A production report traces the flow of units through a department, identifies
the costs charged to the department, shows the computation of unit costs, and
reveals the disposition of the department’s costs for the reporting period.
1 Service and Manufacturing Firms
►Any product or service that is basically
homogeneous and repetitively produced can take
advantage of a process-costing approach.
►Let’s look at three possibilities: services,
manufacturing firms with a just-in-time (JIT)
orientation, and traditional manufacturing firms.
1 Service Firms and Process Costing
►It is possible for firms engaged in service production
to have WIP inventories.
►For example, an accounting firm can have a batch of tax
returns that are partially completed.
►Process costing for services is relatively simple.
►The total costs for the period are divided by the
number of services provided to compute unit cost:
1 Manufacturing Firms Using JIT
►Manufacturing firms may also operate without
significant WIP inventories.
►Specifically, firms that have adopted a JIT approach
try to reduce WIP inventories to very low levels.
►Furthermore, JIT firms usually structure their
manufacturing so that process costing can be used to
determine product costs.
1 Manufacturing Firms Using JIT
(continued)
►In many JIT firms, work cells are created that

produce a product or subassembly from start to
finish.
►Costs are collected by cell for a period of time, and
output for the cell is measured for the same period.
► Unit costs are computed by dividing the costs of the
period by output of the period:
1 Traditional Manufacturing Firms
►On the other hand, traditional manufacturing firms
may have significant beginning and ending WIP
inventories.
►This causes complications in process costing due to
several factors such as the presence of beginning
and ending WIP inventories and different
approaches to the treatment of beginning inventory
cost.
2 The Impact of Work-In-Process
Inventories on Process Costing
►The computation of unit cost for the work
performed during a period is a key part of the
production report.
►This unit cost is needed both to compute the cost of
goods transferred out of a department and to value
ending work-in-process (EWIP) inventory.
The Impact of Work-In-Process
2
Inventories on Process Costing
(continued)
► Conceptually, calculating the unit cost is easy—just divide

total cost by the number of units produced. However, the
presence of WIP inventories causes two problems:
1. Defining the units produced can be difficult, given that some units
produced during a period are complete, while those in ending
inventory are not. This is handled through the concept of equivalent
units of production.
2. How should the costs and work of beginning work-in-process
(BWIP) be treated? Should they be counted with the current period
work and costs or treated separately? Two methods have been
developed to solve this problem: the weighted average method and
the FIFO method.
2 Equivalent Units of Production
► By definition, EWIP is not complete.
► Thus, a unit completed and transferred out during the period
is not identical (or equivalent) to one in EWIP inventory, and
the cost attached to the two units should not be the same.
► In computing the unit cost, the output of the period must be
defined, a significant issue for process costing.
2 Equivalent Units of Production
(continued)
► The solution is to calculate equivalent units of output.

► Equivalent units of output are the complete units that could
have been produced given the total amount of manufacturing
effort expended for the period under consideration.
► Determining equivalent units of output for transferred-out
units is easy; a unit would not be transferred out unless it was
complete.
► Thus, every transferred-out unit is an equivalent unit.
► Units remaining in EWIP inventory, however, are not
complete.
► Thus, someone in production must ‘‘eyeball’’ EWIP to
estimate its degree of completion.
Cornerstone 6-2
2 Calculating Equivalent Units of Production:
No Beginning Work in Process
Cornerstone 6-2
2 Calculating Equivalent Units of Production:
No Beginning Work in Process (continued)
2 Ethical Decisions and
Estimating Completeness
► Estimating the degree of completion is an act that requires
judgment and ethical behavior.
► Overestimating the degree of completion will increase the
equivalent units of output and decrease per-unit costs.
► This outcome, in turn, would cause an increase in both
income (cost of goods sold will be less) and in assets (WIP cost
will increase).
► Deliberately overestimating the degree of completion would
clearly be in violation of ethical professional practice.
Cornerstone 6-3
2 Measuring Output and Assigning Costs:
No Beginning Work in Process
2 Two Methods of Treating Beginning
Work-in-Process Inventory
►In computing a current-period unit cost for a
department, two approaches have evolved for
dealing with the prior-period output and prior-period
costs found in BWIP:
1. The weighted average costing method and
2. The FIFO costing method.
2 The Weighted Average
Costing Method
► The weighted average costing method combines beginning
inventory costs and work done with current-period costs and
work to calculate this period’s unit cost.
► In essence, the costs and work carried over from the prior
period are counted as if they belong to the current period.
► Thus, beginning inventory work and costs are pooled with
current work and costs, and an average unit cost is computed
and applied to both units transferred out and units remaining
in ending inventory.
2 The FIFO Costing Method
► The FIFO costing method separates work and costs of the equivalent
units in beginning inventory from work and costs of the equivalent
units produced during the current period.
► Only current work and costs are used to calculate this period’s unit
cost.
► It is assumed that units from beginning inventory are completed first
and transferred out.
► The costs of these units include the costs of the work done in the prior
period as well as the current period costs necessary to complete the
units.
► Units started in the current period are divided into two categories:
1. units started and completed and
2. units started but not finished (EWIP).
► Units in both of these categories are valued using the current period’s
cost per equivalent unit.
2 IMPORTANT POINT
►If product costs do not change from period to

period, or if there is no BWIP inventory, the
FIFO and weighted average methods yield
the same results.
You Decide
2
Estimating the
Degree of Completion Scenarios
You are the cost accounting manager for a plant that produces riding lawn
mowers. The plant manager receives a bonus at the end of each quarter if the
plant’s income meets or exceeds the quarter’s budgeted income. The plant had
no work in process at the beginning of the quarter; however, it had 2,500 partially
completed units at the end of the quarter. During the quarter, 4,000 units were
completed and sold. Manufacturing costs for the quarter totaled $2,750,000. The
production line supervisors estimated that the units in process at the end of the
quarter were 40 percent finished. Using this initial estimate, the income for the
quarter was $190,000 less than the quarter’s budgeted profit. After seeing this
tentative result, the plant manager approaches you and argues that the degree of
the completion is underestimated and that it should be 60 percent and not 40
percent. He explains that he personally examined the partially completed work
and that 60 percent is his best guess. He would prefer that this new estimate be
used.
What effect does the estimated degree of completion have on the quarter’s
income? Should you use the new estimate?
You Decide
2
Estimating the
Degree of Completion Scenarios (continued)
3 Weighted Average Costing
► The weighted average costing method treats beginning
inventory costs and the accompanying equivalent output as if
they belong to the current period.
►This is done for costs by adding the manufacturing costs in
BWIP to the manufacturing costs incurred during the
current period.
► The total cost is treated as if it were the current period’s total
manufacturing cost.
►Similarly, beginning inventory output and current period
output are merged in the calculation of equivalent units.
►Under the weighted average method, equivalent units of
output are computed by adding units completed to
equivalent units in EWIP.
Cornerstone 6-4
Weighted Average Method
Cornerstone 6-4
Weighted Average Method (continued)
Cornerstone 6-4
3 Five Steps in Preparing
a Production Report
► The production report is subsidiary to the WIP account for a
department.
► The following five steps describe the general pattern of a
process-costing production report:
1. physical flow analysis
2. calculation of equivalent units
3. computation of unit cost
4. valuation of inventories (goods transferred out and EWIP)
5. cost reconciliation
3
Step 1: Physical Flow Analysis
► The purpose of the physical flow analysis is to trace the physical

units of production.
► Physical units are not equivalent units.
►They are units that may be in any stage of completion.
► Two calculations are needed to construct a physical flow schedule:
► ‘‘Total units to account for’’ must equal the ‘‘Total units accounted
for.’’
Cornerstone 6-5
3 Preparing a Physical Flow Schedule
Cornerstone 6-5
3 Preparing a Physical Flow Schedule (continued)
3 Step 2: Calculation of
Equivalent Units
► The weighted average method treats beginning inventory units as
if they were started and completed during the current period.
► Because of this, the equivalent unit schedule shown in step 2
shows only the total units completed.
► There is no need to show whether the units completed are from
the month in question (July) or from BWIP as was done by
Cornerstone 6-4.
3
Step 3: Computation of Unit Cost
► The weighted average method rolls back and includes the

manufacturing costs associated with the units in BWIP and counts
these costs as if they belong to month in question (July).
► Manufacturing costs are carried over from the prior period and
treated as if they were current period costs.
3
Step 4: Valuation of Inventories
►Cornerstone 6-4 also showed how to value goods

transferred out and EWIP.
►Units completed (from Step 1), equivalent units in EWIP
(from Step 2), and the unit cost (from Step 3) are all
needed to value both goods transferred out and EWIP.
3
Step 5: Cost Reconciliation
►Finally, the cost reconciliation checks to see if the costs

to account for are exactly assigned to inventories.
►Remember, the total costs assigned to goods
transferred out and to EWIP must agree with the total
costs in BWIP and the manufacturing costs incurred
during the current period.
Cornerstone 6-6
3 Preparing a Production Report:
Cornerstone 6-6
3 Evaluation of the
Weighted Average Method
Advantages Disadvantages
► Unit cost computations are ►Inaccuracies in computing
simplified: unit costs for current period
Units in BWIP are treated as those of output and for units in BWIP:
the current period and all If the unit cost in a process is relatively
equivalent units belong to the same stable from one period to the next, the
category when it comes to calculating weighted average method is reasonably
unit costs. accurate. However, if the price of
manufacturing inputs increases
significantly from one period to the
next, the unit cost of current output is
understated, and the unit cost of BWIP
units is overstated.
4
Multiple Inputs and
Multiple Departments
►Accounting for production under process
costing gets complicated because of
►Nonuniform application of manufacturing
inputs and
►Presence of multiple processing departments.
Nonuniform Application of
4
Manufacturing Inputs
►Assuming uniform application of conversion costs
(direct labor and overhead) is not unreasonable.
►Direct labor input is usually needed throughout the process,
and overhead is normally assigned on the basis of direct labor
hours.
►Direct materials, on the other hand, are not as likely to be
applied uniformly.
►In many instances, materials are added either at the beginning
or the end of the process.
Nonuniform Application of
4
Manufacturing Inputs (continued)
► Different percentage completion figures for manufacturing inputs

pose a problem for the calculation of equivalent units, unit cost,
and valuation of EWIP (steps 2-4).
► In such cases, equivalent unit calculations are done for each
category of manufacturing input.
► Thus, equivalent units are calculated for each category of
materials and for conversion cost.
► Next, a unit cost for each category is computed. The individual
category costs are then used in Step 4 to cost out EWIP.
► The total unit cost is used to calculate the cost of goods
transferred out in the same way as when there was only one
input category.
Cornerstone 6-7
4 Calculating Equivalent Units, Unit Costs, and
Valuing Inventories with Nonuniform Inputs
Cornerstone 6-7
4 Calculating Equivalent Units, Unit Costs, and
Valuing Inventories with Nonuniform Inputs (continued)
Production Report:
4 Weighted Average Method
Applying
manufacturing
inputs at different
stages of a
process poses no
serious problems,
though it requires
more effort.
4 Multiple Departments
►In process manufacturing, some departments receive
partially completed goods from prior departments.
►The usual approach is to treat transferred-in goods as a
separate material category when calculating equivalent
units.
►Thus, the department receiving transferred-in goods
would have three input categories:
1. one for the transferred-in materials
2. one for materials added
3. one for conversion costs
4 Transferred-In Goods
►In dealing with transferred-in goods, two important
points should be remembered.
1. The cost of this material is the cost of the goods
transferred out as computed in the prior
department.
2. The units started in the subsequent department
correspond to the units transferred out from the
prior department (assuming that there is a one-to-
one relationship between the output measures of
both departments).
Cornerstone 6-8
4 Calculating the Physical Flow Schedule,
Equivalent Units, and Unit Costs with
Transferred-In Goods
Cornerstone 6-8
Transferred-In Goods (continued)
Cornerstone 6-8
Transferred-In Goods
Appendix 6A: Production Report-
5
First-In, First-Out Costing
►Under the FIFO costing method, the equivalent units
and manufacturing costs in BWIP are excluded from the
current period unit cost calculation.
►This method recognizes that the work and costs carried
over from the prior period legitimately belong to that
period.
5 Differences between the First-In, First-Out
and Weighted Average Methods
FIFO Weighted Average
► More Accurate: If changes ►Most firms use this method
occur in the prices of the due to simplicity.
manufacturing inputs from ►FIFO has little advantage over
one period to the next. weighted average, if unit costs
► Better cost control are calculated for short
► Better pricing decisions periods.
5 First-In, First-Out Method
► Since FIFO excludes prior-period work and costs, it is necessary to
create two categories of completed units:
1. BWIP units (FIFO assumes that units in BWIP are completed
first, before any new units are started)
2. Units started and completed during the current period
► These two categories of completed units are needed in the FIFO
method so that each category can be costed correctly.
► For the units started and completed, the unit cost is obtained by
dividing total current manufacturing costs by the current period
equivalent output.
► However, for the BWIP units, the total associated manufacturing
costs are the sum of the prior period costs plus the costs incurred
in the current period to finish the units.
Cornerstone 6-9
5 Calculating Output and Cost Assignments:
First-In, First Out Method
Cornerstone 6-9
First-In, First Out Method (continued)
Cornerstone 6-9
Cornerstone 6-9
5 Step 1: Physical Flow Schedule
The purpose of Step 1 is to trace the physical units of production. As
with the weighted average method, in the FIFO method, a physical flow
schedule is prepared. This schedule is identical for both.
Step 2:
5
Calculation of Equivalent Units
► From the equivalent unit computation, one difference between
weighted average and FIFO becomes immediately apparent.
► Under FIFO, the equivalent units in BWIP (work done in the prior
period) are not counted as part of the total equivalent work.
► Only the equivalent work to be completed this period is counted.
►In this example the percentage of work done in the prior
period is 75 percent, the percentage left to be completed this
period is 25 percent, or an equivalent of 5,000 additional units
of work.
► The effect of excluding prior period effort is to produce the
current period equivalent output.
►Under FIFO equivalent units are 37,500 units – all current
period output.
5 Step 3: Computation of Unit Cost
►The additional manufacturing costs incurred in the
current period are $10,125.
►Thus, the current period unit manufacturing cost is
$10,125/37,500, or $0.27.
►Notice that the costs of beginning inventory are
excluded from this calculation.
►Only current period manufacturing costs are used.
5 Step 4: Valuation of Inventories
► Cornerstone 6-9 shows FIFO values for EWIP and goods
transferred out.
► Since all equivalent units in ending work in process are current
period units, the cost of EWIP is simply $0.27 X 2,500, or $675,
the same value that the weighted average method would
produce.
► However, when it comes to valuing goods transferred out, a
significant difference emerges between the weighted average
method and FIFO.
► Under weighted average, the cost of goods transferred out is
simply the unit cost times the units completed. Under FIFO,
however, there are two categories of completed units: units
started and completed and Units from beginning inventory. The
cost of each category must be calculated separately and then
summed to obtain the total cost of goods transferred out.
Cornerstone 6-10
Cornerstone 6-10
Cornerstone 6-10
5 Step 5: Cost Reconciliation
►In Step 5, the costs assigned to production are
reconciled to the total manufacturing costs to
account for.
►With the completion of Step 5, the production
report can be prepared.

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Chapter 6:

Cornerstones of Managerial Accounting, 4e

► Sequential processing requires that units pass through one

► Parallel processing is another processing pattern that

► Partially completed units (e.g., two subcomponents) can be

► A production report is divided into the following sections

►In many JIT firms, work cells are created that

► Conceptually, calculating the unit cost is easy—just divide

► The solution is to calculate equivalent units of output.

►If product costs do not change from period to

► The purpose of the physical flow analysis is to trace the physical

► The weighted average method rolls back and includes the

►Cornerstone 6-4 also showed how to value goods

►Finally, the cost reconciliation checks to see if the costs

► Different percentage completion figures for manufacturing inputs

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