Chapter 4

Systems Design:
Process Costing
Similarities Between Job-Order
and Process Costing

Both systems assign material, labor and overhead costs

to products and they provide a mechanism for
computing unit product cost.
Both systems use the same manufacturing accounts,
including Manufacturing Overhead, Raw Materials,
Work in Process, and Finished Goods.
The flow of costs through the manufacturing accounts
is basically the same in both systems.

4-2
Differences Between Job-Order
and Process Costing
Process costing is used when a single product is produced on a
continuing basis or for a long period of time. Job-order costing
is used when many different jobs are worked on each period.
Process costing systems accumulate costs by department.
Job-order costing systems accumulated costs by individual jobs.
Process costing systems use department production reports to
accumulate costs. Job-order costing systems use job cost sheets
to accumulate costs.
Process costing systems compute unit costs by department.
Job-order costing systems compute unit costs by job.

4-3
What is a Processing Department?

Any location in an organization where materials,

labor or overhead are added to the product.
The activities performed in a processing
department are performed uniformly on all
units of production. Furthermore, the output
of
a processing department must be
homogeneous.

4-4
Learning Objective

LO1

To record the flow

of materials, labor, and
overhead through a
process costing system.

4-5
T-Account and Journal Entry
Views of Cost Flows

For purposes of this example,

assume there are two
processing departments –
Departments A and B.
We will use T-accounts and
journal entries.

4-6
Process Cost Flows
(in T-account form)
Work in Process
Raw Materials Department A
•Direct •Direct
Materials Materials

Work in Process
Department B
•Direct
Materials

4-7
Process Cost Flows
(in journal entry form)

4-8
Process Cost Flows
(in T-account form)
Work in Process
Wages Payable Department A
•Direct
•Direct Materials
Labor •Direct
Labor

Work in Process
Department B
•Direct
Materials
•Direct
Labor

4-9
Process Cost Flows
(in journal entry form)

4-10
Process Cost Flows
(in T-account form)
Work in Process
Department A
Manufacturing •Direct
Overhead Materials
•Direct
•Actual •Overhead Labor
Overhead Applied to •Applied
Work in Overhead
Process
Work in Process
Department B
•Direct
Materials
•Direct
Labor
•Applied
4-11
Overhead
Process Cost Flows
(in journal entry form)

4-12
Process Cost Flows
(in T-account form)

Work in Process Work in Process

Department A Department B
•Direct Transferred •Direct
Materials to Dept. B Materials
•Direct •Direct
Labor Labor
•Applied •Applied
Overhead Overhead
•Transferred
from Dept. A

4-13
Process Cost Flows
(in journal entry form)

4-14
Process Cost Flows
(in T-account form)

Work in Process
Department B Finished Goods
•Direct •Cost of •Cost of
Materials Goods Goods
•Direct Manufactured Manufactured
Labor
•Applied
Overhead
•Transferred
from Dept. A

4-15
Process Cost Flows
(in journal entry form)

4-16
Process Cost Flows
(in T-account form)

Work in Process
Department B Finished Goods
•Direct •Cost of •Cost of •Cost of
Materials Goods Goods Goods
•Direct Manufactured Manufactured Sold
Labor
•Applied
Overhead
•Transferred
from Dept. A Cost of Goods Sold

•Cost of
Goods
Sold

4-17
Process Cost Flows
(in journal entry form)

4-18
Equivalent Units of Production

Equivalent units are the product of the number of

partially completed units and the percentage
of completion of those units.

We need to calculate equivalent units because a

department usually has some partially completed units
in its beginning and ending inventory.
4-19
Equivalent Units – The Basic Idea

Two half completed products are

equivalent to one completed product.

+ = 1

So, 10,000 units 70% complete

are equivalent to 7,000 complete units.
4-20
Quick Check ✔

For the current period, Jones started 15,000

units and completed 10,000 units, leaving
5,000 units in process that are 30 percent
complete. How many equivalent units of
production did Jones have for the period?
a. 10,000
b. 11,500
c. 13,500
d. 15,000
4-21
Quick Check ✔

For the current period, Jones started 15,000

units and completed 10,000 units, leaving
5,000 units in process that are 30 percent
complete. How many equivalent units of
production did Jones have for the period?
a. 10,000
10,000 units + (5,000 units × 0.30)
b. 11,500 = 11,500 equivalent units
c. 13,500
d. 15,000
4-22
Learning Objective

LO2

To compute the
equivalent units of
production using the
weighted-average
method.

4-23
Calculating Equivalent Units

Equivalent units can be calculated two

ways:
❶The First-In, First-Out Method – FIFO is
covered in the appendix to this chapter.
❷The Weighted-Average Method – This
method will be covered in the main portion of the
chapter.

4-24
Equivalent Units of Production
Weighted-Average Method
The weighted-average method . . .
• Makes no distinction between work done in prior or
current periods.
• Blends together units and costs from prior and
current periods.

Cost per Costs for the period

equivalent = Equivalent units of production
unit for the period

4-25
Process Costing and Direct Labor
Direct
Materials Direct labor costs
may be small
in comparison to
Dollar Amount

Overhead other product

costs in process
Direct cost systems.
Labor

Type of Product Cost

4-26
Process Costing and Direct Labor
Direct
Materials Direct labor costs
Conversion
may be small
in comparison to
Dollar Amount

other product
costs in process
cost systems.

Type of Product Cost

Direct labor and manufacturing overhead may be
combined into one product cost called conversion.
4-27
Weighted-Average Example

Smith Company reported the following activity in

Department A for the month of June:

4-28
Weighted-Average Example

The first step in calculating the equivalent units is to

identify the units completed and transferred out of
Department A in June (5,400 units)

4-29
Weighted-Average Example
The second step is to identify the equivalent units of
production in ending work in process with respect to
materials for the month (540 units) and add this to the
5,400 units from step one.

4-30
Weighted-Average Example
The third step is to identify the equivalent units of
production in ending work in process with respect
to conversion for the month (270 units) and add
this to the 5,400 units from step one.

4-31
Weighted-Average Example

Equivalent units of production always equals:

Units completed and transferred
+ Equivalent units remaining in work in process

4-32
Weighted-Average Example

Materials 6,000 Units Started

Beginning Ending
Work in Process 5,100 Units Started Work in Process
300 Units and Completed 900 Units
40% Complete 60% Complete

5,400 Units Completed

540 Equivalent Units 900 × 60%
5,940 Equivalent units
4-33 of production
Weighted-Average Example

Conversion 6,000 Units Started

Beginning Ending
Work in Process 5,100 Units Started Work in Process
300 Units and Completed 900 Units
20% Complete 30% Complete

5,400 Units Completed

900 × 30%
270 Equivalent Units
5,670 Equivalent units
4-34 of production
Production Report – Weighted-Average

Production Report
❶ A quantity schedule
showing the flow of units
Section 1 and the computation of
equivalent units.

Section 2 ❷ A computation of
cost per equivalent unit.

Section 3

4-35
Production Report

Production Report

Section 1

Section 2
❸ Cost Reconciliation section
shows the reconciliation of
all cost flows into and out of
Section 3 the department during the
period.
4-36
Production Report Example

• Assume that Double Diamond Skis uses the

weighted-average method of process costing to
determine unit costs in it Shaping and Milling
Department.

4-37
Production Report Example
Work in process, May 1: 200 units
Materials: 55% complete $ 9,600
Conversion: 30% complete 5,575

Production started during May 5,000 units

Production completed during May 4,800 units

Costs added to production in May

Materials cost $ 368,600
Conversion cost 350,900

Work in process, May 31 400 units

Materials: 40% complete
Conversion: 25% complete

4-38
Learning Objective

LO3

To prepare a quantity
schedule using the
weighted-average
method.

4-39
Production Report Example

Step1: Prepare Quantity Schedule with Equivalent Units.

4-40
Production Report Example

Step1: Prepare Quantity Schedule with Equivalent Units.

4-41
Production Report Example

Step1: Prepare Quantity Schedule with Equivalent Units.

4-42
Learning Objective

LO4

To compute the costs

per
equivalent unit using the
weighted-average
method.

4-43
Step 2: Calculating the
Costs Per Equivalent Unit

To calculate the cost per equivalent unit

for the period:

Cost per Costs for the period

equivalent = Equivalent units of production
unit for the period

4-44
Production Report Example
Step 2: Compute the cost per equivalent unit.

4-45
Production Report Example
Step 2: Compute the cost per equivalent unit.

$378,200 ÷ 4,960 units = $76.25

4-46
Production Report Example
Step 2: Compute the cost per equivalent unit.

$356,475 ÷ 4,900 units = $72.75

4-47
Learning Objective

LO5

To prepare a cost
reconciliation using the
weighted-average
method.

4-48
Production Report Example
Step 3: Prepare a Cost Reconciliation

4-49
Production Report Example
Step 3: Prepare a Cost Reconciliation

4,800 units @ $149.00

4-50
Production Report Example
Step 3: Prepare a Cost Reconciliation

160 units @ $76.25

100 units @ $72.75

All costs
accounted for

4-51
Appendix 4A

FIFO Method
FIFO vs. Weighted-Average Method

The FIFO method (generally considered more

accurate than the weighted-average method)
differs from the weighted-average method in
two ways:
1. The computation of equivalent units.
2. The way in which the costs of beginning
inventory are treated in the cost
reconciliation report.

4-53
Learning Objective

LO1

To compute the
equivalent units of
production using
the FIFO method.

4-54
Equivalent Units – FIFO Method

Let’s revisit the Smith Company example.

Assume the following activity is reported in
Department A for the month of June:

4-55
Equivalent Units – FIFO Method

Step 1: Determine the number of units completed and

transferred out of Department A in June.

4-56
Equivalent Units – FIFO Method
Step 2: Add the equivalent units of production in ending
work in process inventory (540 units for material and
270 units for conversion) to the units completed and
transferred our during June.

4-57
Equivalent Units – FIFO Method
Step 3: Subtract the equivalent units in beginning work in process
inventory (120 units for materials and 60 units for conversion)
from the sum of the units completed and transferred out and
the equivalent units in ending work in process inventory.

4-58
Equivalent Units – FIFO Method

Materials 6,000 Units Started

Beginning Ending
Work in Process 5,400 Units Started Work in Process
300 Units and Completed 900 Units
40% Complete 60% Complete

4-59
Equivalent Units – FIFO Method

Conversion 6,000 Units Started

Beginning Ending
Work in Process 5,400 Units Started Work in Process
300 Units and Completed 900 Units
20% Complete 30% Complete

4-60
Equivalent Units: Weighted Average vs.
FIFO
As shown below, the equivalent units in beginning inventory are
subtracted from the equivalent units of production per the
weighted-average method to obtain the equivalent units of production
under the FIFO method.

4-61
The Production Report - FIFO Method
Let’s revisit the Double Diamond Skis Shaping and Milling
Department for May to prepare our production report.
Work in process, May 1: 200 units
Materials: 55% complete $ 9,600
Conversion: 30% complete 5,575

Production started during May 5,000 units

Production completed during May 4,800 units

Costs added to production in May

Materials cost $ 368,600
Conversion cost 350,900

Work in process, May 31 400 units

Materials: 40% complete
4-62Conversion: 25% complete
Learning Objective

LO2

To prepare a
quantity schedule
using the FIFO
method.

4-63
The Production Report - FIFO Method
Step 1: Prepare the quantity schedule and compute
equivalent units.

4-64
The Production Report - FIFO Method
Step 2: Calculate the equivalent units of material and conversion
that were transferred from beginning work in process to
the next department.

4-65
The Production Report - FIFO Method
Step 3: Determine the number of units started and
completed during the period.

4-66
The Production Report - FIFO Method
Step 4: Calculate the equivalent units of material and
conversion that are in ending work in process
inventory.

4-67
The Production Report - FIFO Method
Step 5: Calculate the total equivalent units for
materials and conversion.

4-68
Learning Objective

LO3

To compute the costs

per equivalent unit
using the FIFO method.

4-69
Cost per Equivalent Unit
Notice that the costs of beginning work in process
inventory of $15,175, is not broken down by
materials and conversion components

4-70
Cost per Equivalent Unit
We divide the costs added in the Shipping
and Milling Department by the number of
equivalent unit for materials.

4-71
Cost per Equivalent Unit
We follow the same procedure for conversion
and add the two equivalent unit costs to get
the total cost per equivalent unit.

4-72
Learning Objective

LO4

To prepare a cost
reconciliation using
the FIFO method.

4-73
Cost Reconciliation
Step 1: Calculate the total cost from beginning
inventory transferred to the next department.

4-74
Cost Reconciliation
Step 2: Calculate the cost of units started and
completed during the period.
4,600 units × $148.50

4-75
Cost Reconciliation
Step 3: Calculate the costs in ending working in process
inventory and the sum of the cost accounted for.

All costs
4-76 accounted for