Chapter 3 Process Costing Learning Objectives After studying

Chapter 3 Process Costing Learning Objectives After studying this chapter, you should be able to: [1] Understand who uses process cost systems. [2] Explain the similarities and differences between job order cost and process cost systems. [3 Explain the flow of costs in a process cost system. [4] Make the journal entries to assign manufacturing costs in a process cost system. [5] Compute equivalent units. [6] Explain the four steps necessary to prepare a production cost report. [7] Prepare a production cost report. 3 -1

Nature of Process Cost Systems Uses of Process Cost Systems u Use to apply costs to similar products that are massproduced in a continuous fashion u Examples include the production of Cereal, Paint, Manufacturing Steel, Oil Refining and Soft Drinks Illustration 3 -1 3 -2 LO 1 Understand who uses process cost systems.

Nature of Process Cost Systems Process and Job Cost Comparison Illustration 3 -2 3 -3 LO 1 Understand who uses process cost systems.

Nature of Process Cost Systems Process Costing for Service Companies Service companies that provide specific, nonroutine services will probably benefit from using a job order cost system. Those that perform routine, repetitive services will probably be better off with a process cost system. 3 -4 LO 1 Understand who uses process cost systems.

Nature of Process Cost Systems Similarities and Differences Between Job Order Cost and Process Cost Systems Job Order Cost 3 -5 Process Cost u Costs assigned to each job. u u Products have unique characteristics. Costs assigned to each department. u Products are uniform or relatively homogeneous and produced in a large volume. LO 2 Explain the similarities and differences between job order cost and process cost systems.

Nature of Process Cost Systems Illustration 3 -3 Job order cost and process cost flow Illustration 3 -3 3 -6 LO 2 Explain the similarities and differences between job order cost and process cost systems.

Indicate whether the following statements are true or false. False 1. A law firm is likely to use process costing for major lawsuits. True 2. A manufacturer of paintballs is likely to use process False 3. Both job order and process costing determine product costing. costs at the end of a period of time, rather than when a product is completed. False 3 -7 4. Process costing does not keep track of manufacturing overhead. LO 2

Nature of Process Cost Systems Process Cost Flow Tyler Company manufactures roller blade and skateboard wheels that it sells to manufactures and retail outlets. Manufacturing consists of two processes: machining and assembly. The Machining Department shapes, hones, and drills the raw materials. The Assembly Department assembles and packages the parts. Illustration 3 -5 3 -8 LO 3 Explain the flow of costs in a process cost system.

Nature of Process Cost Systems Assigning Manufacturing Costs u u 3 -9 Accumulation of materials, labor, and overhead costs is same as in job order costing. ► Debit Raw Materials Inventory for purchases of raw materials. ► Debit Factory Labor factory labor incurred. ► Debit Manufacturing Overhead for overhead cost incurred. Assignment of the three manufacturing cost elements to Work in Process in a process cost system is different from a job order cost system LO 4 Make the journal entries to assign manufacturing costs in a process cost system.

Two important key terms and one assumption 3 -10 l Conversion cost: the costs that represents activities that turn a raw material into finished products. Labor costs and manufacturing overhead combined will be conversion cost. l Assumption: Materials are entered at the beginning of the process, labor and manufacturing overhead are added gradually throughout the process. l Equivalent Units (of production): a measure of how hard we worked expressed in completed (finished) units. l Use the weighted average method (not FIFO method).

l Equivalent Units (EU)-Why do we need this number? You are a company that makes Youphone. You tell your boss proudly after one month’s work: Finished goods: 1, 200 units Unfinished goods: 800 units—only 70% complete l Your boss: just tell me how many units of goods have you finished this month? I want a number for the finished goods!!! Equivalent (finished) Units = 1, 200 + 800* 70% = 1, 760 units 1, 200 (finished units) + 800 (partially-70% completed units) ~ 1, 760 EU (Note that the Percentage of completion is the key here). Why is this number important? (Total costs /total units finished = cost/unit) 3 -11

l Why is the EU number important? : Total cost incurred during the production process: 1) total material cost + total Conversion cost (labor +overhead) = total 76, 000 100, 000 = $176, 000 2) Total units /total EU = 1, 760 so, unit cost = $ /unit Two important things to remember when calculating EU: 1) the beginning balance of unfinished work (or beginning WIP inventory) does NOT matter (All the boss cares about is: at the end of the month/year, how much work you have done? And what is EQ for the work you did? ) 2) Percentage of completion (%) is the key here. 3 -12

Equivalent Units Weighted Average Method Illustration: The output of Kori Company’s Packaging Department during the period consists of 10, 000 units completed and transferred out, and 5, 000 units in ending work in process which are 70% completed. Calculate the equivalent units of production. 3 -13 Completed units 10, 000 Work in process equivalent units (5, 000 x 70%) 3, 500 13, 500 LO 5 Compute equivalents units.

Equivalent Units—a more difficult example Refinements on the Weighted-Average Method Illustration: Kellogg Company has produced Eggo® Waffles since 1970. Three departments produce these waffles: Mixing, Baking, and Freezing/Packaging. The Mixing Department combines dry ingredients, including flour, salt, and baking powder, with liquid ingredients, including eggs and vegetable oil, to make waffle batter. Illustration 3 -9 provides information related to the Mixing Department at the end of June. 3 -14 LO 5 Compute equivalents units.

Equivalent Units Refinements on the Weighted-Average Method Illustration: Information related to the Mixing Department at the end of June. 3 -15 Illustration 3 -9 Notice that the Percentage of Completion is different for materials and conversion costs. Remember the assumption?

Equivalent Units Illustration 3 -10 u Conversion costs are labor costs plus overhead costs. u Beginning work in process is not part of the equivalentunits-of-production formula. 3 -16 LO 5 Compute equivalents units.

Equivalent Units Review Question The Mixing Department’s output during the period consists of 20, 000 units completed and transferred out, and 5, 000 units in ending work in process 60% complete as to materials and conversions costs. Beginning inventory is 1, 000 units, 40% complete as to materials and conversion costs. The equivalent units of production are: 3 -17 a. 22, 600 b. 23, 000 c. 24, 000 d. 25, 000 LO 5 Compute equivalents units.

The fabricating department has the following production and cost data for the current month. Beginning Work in Process – 0– Units Transferred Out 15, 000 Ending Work in Process 10, 000 Materials are entered at the beginning of the process. The ending work in process units are 30% complete as to conversion costs. Compute the equivalent units of production for (a) materials and (b) conversion costs. 3 -18 LO 5 Compute equivalents units.

The fabricating department has the following production and cost data for the current month. Beginning Work in Process – 0– Units Transferred Out 15, 000 Ending Work in Process 10, 000 Compute the equivalent units of production for (a) materials and (b) conversion costs. 3 -19 Units transferred out 15, 000 Ending work in process units 10, 000 25, 000 LO 5 Compute equivalents units.

The fabricating department has the following production and cost data for the current month. Beginning Work in Process – 0– Units Transferred Out 15, 000 Ending Work in Process 10, 000 Compute the equivalent units of production for (a) materials and (b) conversion costs. 3 -20 Units transferred out 15, 000 Equivalent unit in ending WIP (10, 000 x 30%) 3, 000 18, 000 LO 5 Compute equivalents units.

Production Cost Report A production cost report is the u Key document used to understand activities. u Prepared for each department and shows Production Quantity and Cost data. u Four steps in preparation: Step 1: Compute physical unit flow Step 2: Compute equivalent units of production Step 3: Compute unit production costs Step 4: Prepare a cost reconciliation schedule 3 -21 LO 6 Explain the four steps necessary to prepare a production cost report.

Production Cost Report Illustration 3 -12 Flow of costs in making Eggo® Waffles 3 -22 LO 6 Explain the four steps necessary to prepare a production cost report.

Production Cost Report Illustration 3 -13 Unit and cost data—Mixing Department 3 -23 LO 6

Production Cost Report Compute the Physical Unit Flow (Step 1) 3 -24 u Physical units - actual units to be accounted for during a period, regardless of work performed. u Total units to be accounted for - units started (or transferred) into production during the period + units in production at beginning of period. u Total units accounted for - units transferred out during period + units in process at end of period. LO 6 Explain the four steps necessary to prepare a production cost report.

Production Cost Report Compute the Physical Unit Flow (Step 1) Illustration 3 -14 3 -25 LO 6 Explain the four steps necessary to prepare a production cost report.

Production Cost Report Compute Equivalent Units of Production (Step 2) Mixing Department u Department adds materials at beginning of process and u Incurs conversion costs uniformly during the process. Illustration 3 -15 3 -26 LO 6 Explain the four steps necessary to prepare a production cost report.

Production Cost Report Compute Unit Production Costs (Step 3) u Costs expressed in terms of equivalent units of production. u When equivalent units of production are different for materials and for conversion costs, three unit costs are computed: 1. Materials 2. Conversion 3. Total Manufacturing 3 -27 LO 6 Explain the four steps necessary to prepare a production cost report.

Production Cost Report Compute Unit Production Costs (Step 3) Compute total materials cost related to Eggo® Waffles: Work in process, June 1 Direct materials costs Illustration 3 -16 $ 50, 000 Cost added to production during June Direct material cost Total material costs 400, 000 $450, 000 Illustration 3 -17 3 -28 LO 6

Production Cost Report Compute Unit Production Costs (Step 3) Compute total conversion costs related to Eggo® Waffles: Work in process, June 1 Conversion costs Illustration 3 -18 $ 35, 000 Costs added to production during June Conversion costs Total conversion costs 170, 000 $205, 000 Illustration 3 -19 3 -29 LO 6

Production Cost Report Compute Unit Production Costs (Step 3) Illustration 3 -19 Compute total manufacturing costs per unit: 3 -30 Illustration 3 -20 LO 6 Explain the four steps necessary to prepare a production cost report.

Production Cost Report Prepare a Cost Reconciliation Schedule (Step 4) Kellogg charged total costs of $655, 000 to the Mixing Department in June, calculated as follows. Costs to be accounted for Work in process, June 1 Started into production Total costs 3 -31 Illustration 3 -21 $ 85, 000 570, 000 $655, 000 LO 6 Explain the four steps necessary to prepare a production cost report.

Production Cost Report Illustration 3 -22 3 -32 LO 6 Explain the four steps necessary to prepare a production cost report.

Illustration 3 -23 Production Cost Report Prepare the Production Cost Report 3 -33 LO 7

Production Cost Report Review Question Largo Company has unit costs of $10 for materials and $30 for conversion costs. If there are 2, 500 units in ending work in process, 40% complete as to conversion costs and fully complete as to materials cost, the total cost assignable to the ending work in process inventory is: 3 -34 a. $45, 000. b. $55, 000. c. $75, 000. d. $100, 000. LO 7 Prepare a production cost report.

In March, Rodayo Manufacturing had the following unit production costs: materials $6 and conversion costs $9. On March 1, it had zero work in process. During March, Rodayo transferred out 12, 000 units. As of March 31, 800 units that were 25% complete as to conversion costs and 100% complete as to materials were in ending work in process. Assign the costs to the units transferred out and in process. Costs transferred out $180, 000 Work in process, March 31 Materials (800 x $6) Conversion costs (200 x $9) Total costs 3 -35 $4, 800 1, 800 $186, 600 LO 7 Prepare a production cost report.

Other Exercises: Some Journal Entries in Process Cost Systems Material Costs u 3 -36 A process cost system requires fewer material requisition slips than a job order cost system. ► Materials are used for processes and not specific jobs. ► Requisitions are for larger quantities of materials. ► Journal entry to record materials used: LO 4 Make the journal entries to assign manufacturing costs in a process cost system.

Nature of Process Cost Systems Factory Labor Costs 3 -37 u Time tickets may be used in both systems. u All labor costs incurred within a production department are a cost of processing. u The journal entry to record factory labor costs: LO 4 Make the journal entries to assign manufacturing costs in a process cost system.

Nature of Process Cost Systems Manufacturing Overhead Costs 3 -38 u Objective of assigning overhead is to allocate overhead to production departments on objective and equitable basis. u Use the activity that “drives” or causes the costs. u Machine time used - primary driver. u Journal entry to allocate overhead: LO 4 Make the journal entries to assign manufacturing costs in a process cost system.

Nature of Process Cost Systems Transfers Monthly Entry to transfer goods to next department: Entry to transfer completed goods to Finished Goods: Entry to record Cost of Goods sold at the time of sale: 3 -39 LO 4

Blue Diamond Company manufactures ZEBO through two processes: blending and bottling. In June, raw materials used were Blending $18, 000 and Bottling $4, 000. Factory labor costs were Blending $12, 000 and Bottling $5, 000. Manufacturing overhead costs were Blending $6, 000 and Bottling $2, 500. The company transfers units completed at a cost of $19, 000 in the Blending Department to the Bottling Department. The Bottling Department transfers units completed at a cost of $11, 000 to Finished Goods. Journalize the assignment of these costs to the two processes and the transfer of units as appropriate. 3 -40 LO 4 Make the journal entries to assign manufacturing costs in a process cost system.

Journalize the assignment of these costs to the two processes. To Record Materials Used: Work in Process—Blending 18, 000 Work in Process—Bottling 4, 000 Raw Materials Inventory 22, 000 To Assign Factory Labor to Production: Work in Process—Blending 12, 000 Work in Process—Bottling 5, 000 Factory Labor 3 -41 17, 000 LO 4

Journalize the assignment of these costs to the two processes. To Assign Overhead to Production: Work in Process—Blending 6, 000 Work in Process—Bottling 2, 500 Manufacturing Overhead 3 -42 8, 500 LO 4 Make the journal entries to assign manufacturing costs in a process cost system.

Journalize the transfer of units as appropriate. To Record Transfer of Units to the Bottling Department: Work in Process—Bottling 19, 000 Work in Process—Blending 19, 000 To Record Transfer of Units to Finished Goods: Finished Goods Inventory Work in Process—Bottling 3 -43 11, 000 LO 4 Make the journal entries to assign manufacturing costs in a process cost system.

Production Cost Report Costing Systems – Final Comments u Companies often use a combination of a process cost and a job order cost system. 3 -44 u Called operations costing, this hybrid system is similar to process costing in its assumption that standardized methods are used to manufacture the product. u At the same time, the product may have some customized, individual features that require the use of a job order cost system. LO 7 Prepare a production cost report.