ACA 211 Cost Accounting and Control

Lesson 5: Process Costing Lecture Notes

I. Terminology
Continuous loss is a loss that occurs fairly uniformly through the production process.

Cost of production report a process costing document that details all operating and cost information,
shows the computation of cost per equivalent unit, and indicates cost assignment to goods produced during
the period

Discreet loss is assumed to occur at a specific point and is detectible only when a quality check is
performed.

Equivalent units of production (EUP) are approximations of the number of whole units of output that could
have been produced during a period from the actual effort expended during that period; used in process
costing systems to assign costs to production

FIFO method (of process costing) is a method that separates beginning inventory and current period
production and their costs so that a current period cost per unit can be calculated. The denominator used
in the cost formula to determine the unit cost differs, depending on whether the FIFO or weighted average
methods are used.

Hybrid costing system a costing system combining characteristics of both job order and process costing
systems

Method of neglect simply excludes the spoiled units in the equivalent units schedule. The costs of normal
shrinkage and normal continuous losses in a process costing environment are handled through the method
of neglect. Ignoring the spoilage results in a smaller number of equivalent units of production (EUP), and
dividing production costs by a smaller EUP raises the cost per equivalent unit, thus spreading the cost of lost
units proportionately over the good units transferred and those remaining in WIP.

Total cost to account for the sum of the balance in Work in Process Inventory at the beginning of the period
plus all current costs for direct material, direct labor, and overhead.

Total units to account for the sum of the whole and partial units worked on in the department using the
current period: It is equal to actual beginning inventory units and units started during the current period

Units started and completed during a period is equal to units completed during the period minus units in
beginning inventory. It can also be computed as the number of units started during the period minus the
units in ending inventory

Weighted average method (of process costing) is a method of cost assignment that computes a single
average cost per unit of the combined beginning inventory and current period production.

II. LECTURE NOTES

1. Introduction to Process Costing.
i. Job-order costing is appropriate for companies making products or providing services in
limited quantities that conform to customer specifications.
ii. Both job-order costing and process costing accumulate costs by cost component in each
production department. However, the two systems assign costs to departmental output
differently.
• In job-order costing, costs are assigned to specific jobs and then, if possible, to units
contained within the job.
• Process costing uses an averaging technique to assign costs directly to units produced
during the period.
 iii. Process costing is a method of accumulating and assigning costs to units of production in
companies that make large quantities of homogeneous products.
b. Cost assignment in any production environment is essentially an averaging process.
c. The actual unit cost of a product is found by dividing a period’s departmental production costs
by the period’s departmental quantity of production, the average being expressed by the
following formula:
Sum of Production Costs
Unit Cost 
Production Quantity
2. The numerator.
a. The numerator in the average product cost fraction is the sum of the actual direct materials cost,
actual direct labor cost, and actual or predetermined overhead cost for the period.
b. Cost accumulation in a process costing system differs from job order costing in two ways:
i. the quantity of production for which costs are being accumulated at any one time and:
• in job order costing, the direct materials, direct labor, and overhead costs are
accumulated for each job; or
• in process costing, much larger amounts of direct materials, direct labor, and overhead
are accumulated for each department of a production process.
ii. the cost object to which the costs are assigned:
• in job order costing the cost object is the job; or
• in process costing, the costs assignable to each product type are designated and attached
to the specific production runs; then the costs are assigned to the units worked on during
the period.

3. The denominator.
a. The denominator in the average product cost fraction represents total departmental production
for the period.
b. If all units were 100% complete at the end of the period, we would simply count the units to
obtain the denominator.
c. However, WIP at the end of the period represent partially completed units that become
beginning inventory for the next accounting period.
d. Process costing assigns costs to both fully completed units in finished goods inventory and to the
partially completed units in WIP.
e. We mathematically convert partially completed units into equivalent whole units by calculating
equivalent units of production (EUP).

4. Equivalent units of production (EUP) is an approximation of the number of whole units of output
that could have been produced during a period from the actual effort expended during that period.
Two facts are recognized using equivalent units of production.
a. Goods that were incomplete at the end of the last period are the first ones completed during the
current period. The units in the beginning Work in Process were started last period but will be
completed during the current period—meaning that some costs related to these units were
incurred last period and additional costs will be incurred in the current period.
b. Some units are begun but not completed during the current period. These partially completed
units in the ending Work in Process Inventory were started in the current period but will not be
completed until the next period—meaning that costs were incurred in this period and additional
costs will be incurred next period, due to current production efforts on the ending Work in
Process Inventory.
c. Assuming no beginning inventory, equivalent units of production are calculated using the
following simple example:
The department worked on 220,000 units in November
200,000 units were completed and 20,000 units were 40% complete at the end of the period
EUP = 200,000 completed units + (20,000 x 40%) = 208,000
B. Weighted Average and FIFO Process Costing Methods
1. The weighted average method is a method of process costing that computes an average cost per
equivalent unit of production; it combines beginning inventory units and costs with current
production and costs, respectively, to compute that average.
a. The weighted average method is not concerned about what quantity of work was performed in
the prior period on the units in beginning inventory; it only focuses on units that are completed
in the current period and units remaining in ending inventory.
b. The method does not distinguish between units in beginning inventory and units entering
production during a period.
c. Average unit cost is found by dividing the total cost to be accounted for by the total equivalent
units of production and is calculated as follows:
Beginning Inventory Cost  Current Period Cost
Unit Cost 
Weighted Average Equivalent Units of Production
Total Cost Incurred

Total Equivalent Units of Effort
2. The FIFO method is a method of process costing that computes an average cost per equivalent unit
of production using only current period production and cost information; units and costs in
beginning inventory are separately sent to the next department or to Finished Goods Inventory, as is
appropriate.
a. The FIFO method separates beginning inventory and current period production and their costs
so that a current period cost per unit can be calculated.
b. The FIFO method more realistically reflects the way in which most goods actually flow through
the production system.
c. The method does not commingle units and costs of different periods, so that equivalent units
and costs of beginning inventory are withheld from the computation of average current period
cost.
d. The focus is specifically on the work performed during the current period, and the EUP schedule
shows only that work.
e. The FIFO average cost per equivalent unit is calculated as follows:
Current Period Costs
Unit Cost 
Equivalent Units of Production

3. Separate EUP calculations must be made for each cost component.

a. Some direct material must be introduced at the start of a production process or there would be
no need for labor or overhead to be incurred. The beginning material is one hundred percent
complete throughout the process regardless of the percentage of completion of labor and
overhead.
b. Additional materials may be added at any point—continuously during processing, or even at the
end of processing.
c. A single materials computation may be made if all materials are at the same degree of
completion, or multiple equivalent unit calculations will have to be made if multiple materials
are used and are placed into production at different points in time.
d. One percentage of completion estimates may be made and used for direct labor and overhead if
overhead is applied on a direct labor basis, or direct labor and overhead are added to the
product at the same rate.
e. Overhead costs are more likely to be caused by cost drivers other than direct labor today, so
companies probably will make single computations for “conversion equivalent units” less often
than in the past.
f. The calculation of equivalent units of production requires that a cost flow be specified—either
weighted average or FIFO.
g. The only difference between the calculations under the two methods is that the work performed
in the prior period on beginning inventory is not included in the current period EUP using FIFO.

4. A detailed example of the calculations of equivalent units of production and cost assignment for
each of the cost flow methods is presented in the next section.
C. EUP Calculations and Cost Assignments
1. EUP calculations and cost assignments.
a. Cost must be assigned to goods transferred from WIP to Finished Goods Inventory (or to another
department).
b. In addition, at the end of any period, a value must be assigned to goods still in WIP.
c. Six steps in a process costing system.
i. Step 1: Calculate the physical units to account for;
ii. Step 2: Calculate the physical units accounted for (verify that step 1 equals step 2);
iii. Step 3: Determine the equivalent units of production;
iv. Step 4: Determine the total cost to account for;
v. Step 5: Calculate the cost per equivalent unit; and
vi. Step 6: Assign the costs to inventories (verify that the total costs transferred out plus the
costs in ending inventory equal step 4).
d. The total units to account for are the sum of whole and partial units worked on in the
department during the current period. It is equal to actual beginning inventory units plus actual
units started.
e. The total cost to account for is the sum of the balance in WIP at the beginning of the period plus
all current costs for direct material, direct labor, and overhead.
2. Weighted Average Method.
a. Step 1: Calculate the total units to account for: the
b. Step 2: Calculate the total units accounted for
i. Units fit into one of two categories:
• units completed and transferred out,
• partially completed units remaining in ending WIP.
c. Step 3: Determine EUP (weighted average method).
i. The weighted average EUP calculation uses the units in beginning WIP Inventory and the
units started and completed during the period.
ii. The units started and completed equal the difference between the number of units
completed for the period and the units in beginning inventory; it can also be computed as
the number of units started during the period minus the units in ending inventory.
iii. EUP is completed separately for:
• Direct materials, and
• Labor and overhead.
iv. A single EUP is computed for both labor and overhead because it is assumed that labor and
overhead are added at the same rate throughout the production process.
d. Step 4: Determine total costs to account for.
e. Step 5: Calculate the cost per equivalent unit.
f. Step 6: Assign costs to inventories
g. Total cost assigned to units transferred out are
h. The six steps listed above can be combined into a cost of production report.
i. A cost of production report is a process costing document that details all operating and cost
information, shows the computation of cost per equivalent unit, and indicates cost assignment
to goods produced during the period.
j. The T-Accounts are also provided for WIP and Finished Goods inventories.

3. FIFO Method
a. Steps 1 and 2 are the same for FIFO as they are for the Weighted Average Method.
b. Step 3: Determine EUP under the FIFO Method.
i. Under the FIFO Method, the work performed last period is not commingled with work of the
current period.
ii. Only the work performed on the WIP beginning inventory during the
c. Step 4: Determine the total cost to account for is the same as under the Weighted Average
Method.
d. Step 5: Calculate the cost per equivalent unit.
e. Step 6: Assign costs to inventories.
D. Process Costing in a Multidepartment Setting.
1. Goods are transferred from a predecessor department to a successor department.
2. A successor department may or may not add additional raw materials to the units that were
transferred in or may provide additional labor with a corresponding incurrence of overhead.
3. Successor departments may change the unit of measure from that of predecessor departments.
E. Process Costing with Standard Costs.
1. Standard costing eliminates the periodic re-computation of production cost that is required under
actual costing.
2. Equivalent unit calculations for standard process costing are identical to those of FIFO process
costing.
3. Standard cost usage simplifies process costing and allows variances to be measured during the
period.
F. Hybrid Costing Systems.
1. A hybrid costing system is a costing system that combines certain characteristics of both job order
and process costing.
2. A hybrid system would be used in a manufacturing environment in which various product lines have
different direct materials, but similar processing techniques.
3. Job order and process costing are two ends of a continuum.
4. As the use of flexible manufacturing processes increase, so will the use of hybrid costing systems.
G. Alternative Calculations of Weighted Average and FIFO Methods
1. Alternatively, EUP under the weighted average method may be calculated as follows:
Units transferred out (whole units)
+ Ending WIP (equivalent units)
= Weighted average EUP

2. Alternatively, EUP under the FIFO method may be calculated as follows:

Weighted average EUP
- Beginning WIP (equivalent units)
= FIFO EUP

3. In addition to the first alternative calculation above, weighted average and FIFO EUP can also be
calculated as follows:
a. Alternatively, EUP under the weighted average method may be calculated as follows:

Total units to account for

- EUP to be completed in the next period (EI x % not completed)
= Weighted average EUP

b. Alternatively, EUP under the FIFO method may be calculated as follows:

Weighted average EUP
- EUP completed in the prior period (BI x % complete)
= FIFO EUP

4. These alternative calculations can be used as a confirmation of answers or as a shortcut to initially

compute EUP.

H. Spoilage.
1. Spoilage represents units from the production process that does not meet specifications.
2. Losses in a production process may occur continuously or at a specific point in the production
process.
a. Continuous loss: losses in a production process that occurs fairly uniformly through the process.
b. Discrete loss: a loss that occurs at a specific point in the production process.
3. Several methods may be used to account for units lost during production.
a. Normal continuous losses.
i. In process costing, the costs of normal continuous losses are handled through the method of
neglect, which excludes the spoiled units from EUP.
ii. This results in smaller EUP and raises the cost per equivalent unit.
iii. Therefore, the cost of the normal spoilage is spread proportionately over good units
transferred and those remaining in WIP.
iv. The cost of normal continuous losses is a product cost.
b. Normal discrete losses.
i. The costs of normal discrete losses are assigned only to units that have passed the inspection
point because assigning loss costs to units that may be found to be defective in the next
period would not be reasonable.
ii. The cost of normal discrete losses is a product cost.
c. Abnormal losses, both continuous and discrete, are expensed in the current period.