Chapter 9 - Process Costing: Nature and Operations

According to Pedro P. Guerrero, process costing is a system of accumulating costs of production by

departments or cost center.¹

This accounting system is commonly used by companies where a large number of similar products pass
through different departments in a continuous process until completed in the last department then
transferred to finished goods inventory.¹

Companies where process costing is used include oil refining, chemical processing, and food processing.¹

Objective of Process Costing

The principal objective of process costing is the allocation of manufacturing costs in every department to
calculate the unit cost of the product for profit determination and inventory costing purposes.¹

For example, assume that during the month 1,000 units were started in process in the Department 1.
During the month, costs were incurred as follows:

Direct Materials P150,000

Direct Labor 50,000

Manufacturing Overhead 100,000

At the end of the month, 700 units were completed and transferred to Department 2.

The objective of process cost system is to calculate how much of P150,000 direct materials, P50,000 of
direct labor, and P100,000 of manufacturing overhead costs will be allocated to 700 units completed
and transferred to Department 2 and how much will be allocated to the 300 units still in process in
Department 1.

Comparison of Process Cost and Job Order Cost System

Process cost is used when products are manufactured by mass production.¹

Job order cost system is most suitable when a single product or batch of product is manufactured
according to customer’s specification.¹

¹Pedro P. Guerrero, Cost Accounting – Principles and Procedural Applications, 2018 Edition
Similarities:

a. Manufacturing Cost Elements – Both track and record three elements of costs: direct materials,
direct labor, and manufacturing overhead.¹

b. Accumulation of Costs – Under both costing system, all raw materials purchased are debited to
Materials account; all direct labor are debited to Factory Payroll account; and all actual
manufacturing overhead costs are debited to Manufacturing Overhead Control account.¹

c. Flow of Costs – The accumulated manufacturing costs are assigned to the same accounts in both
costing systems: Work in Process, Finished Goods, and Cost of Goods sold.¹

Differences:

a. Number of Work in Process Accounts Used – In a job order cost system, only one Work in
Process account is used. In a process cost system, multiple Work in Process accounts are used
for each production department.¹

b. Point at Which Total Costs are Determined - In a job order cost system, total costs are
computed when the job is completed. In a process cost system, total costs are determined at
the end of each month while the units are being processed.¹

c. Unit Cost Computation – In a job order cost system, the unit costs is determined by dividing the
total cost per job by the units produced. In a process cost system, the unit cost is equal to the
total manufacturing costs for the period divided by the units produced during the period.¹

Accumulation of Costs by Department

a. Units completed in one department are transferred to the next department accompanied by
their corresponding costs.¹

b. Completed unit of one department becomes the raw materials of the next department until the
units are converted to finished products.¹

c. The output of Department 1 becomes the input of Department 2. Department 2 receives both
the units produced in Department 1 as well as its production costs.¹

d. Upon completion of the process in Department 2, the cost of units completed consists of the
costs received in Department 1 and cost incurred in Department 2.¹

e. The cost of a unit increases as it progresses from one department to the next.¹
Assignment of Manufacturing Costs

Process cost system accumulates the three elements of costs using either the following costing
procedures:

a. Normal Costing – Direct materials and direct labor are applied at actual cost while
manufacturing overhead is applied at a predetermined rate.¹

b. Standard Costing – Direct materials, direct labor, and manufacturing overhead are applied at
Standard cost or estimated cost.¹

The accounting procedures to record the allocation of the three elements (categories) of costs in a
process cost system is different from a job cost system. Units are assumed to have been processed in
three departments ( as illustrated) until they are transferred to finished goods inventory.

a. Direct Materials – The entry to record direct materials used by each department is:

Work in Process –Department 1 xxx

Work in Process – Department 2 xxx

Work in Process – Department 3 xxx

Materials xxx

b. Direct Labor – The distributions of direct labor to the departments are recorded by the following
entry:

Work in Process – Department 1 xxx

Work in Process – Department 2 xxx

Work in Process – Department 3 xxx

Factory Payroll xxx

c. Manufacturing Overhead – Manufacturing overhead costs are applied using a predetermined

application rate. The following entry is made to record applied manufacturing overhead in each
department:

Work in Process – Department 1 xxx

Work in Process – Department 2 xxx

Work in Process – Department 3 xxx

Applied Manufacturing Overhead xxx

 d. Transfer to Next Department – The entry to record the cost of units transferred out:

From Department 1 to Department 2:

Work in Process – Department 2 xxx

Work in Process – Department 1 xxx

From Department 2 to Department 3:

Work in Process – Department 3 xxx

Work in Process – Department 2 xxx

e. Transfer to Finished Goods – The units completed in the last department (Department 3) and
transferred to stockroom awaiting sale are recorded as follows:

Finished Goods xxx

Work in Process – Department 3 xxx

Production Report

At the end of each a month, a production report is prepared for each department by the cost
accountant. A production report shows the number of units that were in process in the department at
the start of the month, the number of units started during the month, the number of units transferred
out of the department during the month, the number of units still in work in process at the end of the
month, and the percentage of completion of the units still in process at the end of the month.¹

Cost of Production Report

Based on the production report and the information about costs incurred during the month, a cost of
production report is prepared for each department at the end of the month. The cost of production
report is the document used by the management to understand and evaluate the operations of a
department because it shows the flow of units as well as the flow of costs related to that department.
The report summarizes the costs incurred in the department, the average cost per unit of product, the
total costs of products completed and transferred out of the department, and the costs related to the
ending inventory of work in process in each department. This report is the source for summary journal
entries for the period.¹

Warehousing

One summary entry is made at the end of the month to record the cost of goods completed during the
month.¹
Selling

The Cost of Goods Sold account is debited and the Finished Goods Inventory account is credited for cost
of products sold.¹

Comprehensive Illustration:

Star Paper Company manufactures high quality paper boxes in three departments. The Cutting
Department that cuts and trims paper to the required dimensions and sizes; the Assembly Department
that folds the paper and form the boxes; and the Packaging Department that put the boxes in a
container for storage, Starting from the Cutting Department, the product moves into the Assembly
Department and then to the Packaging Department. As the production moves from department to
department, the accumulated costs move with it.

Assumed data relating to Star Paper Company for January 200X, the first month of manufacturing
operations are as follows:

Cutting Department

Costs Incurred

The three elements (categories) of manufacturing costs: materials, labor, and overhead incurred and
charged to the Work in Process – Cutting Department for the month of January 200X are presented
below:

Materials P 77,280

Labor 95,616

Overhead 156,632

Production Report

This report shows the physical flow of units for the month of January 200X which includes the following
data:

1. Number of units started in process

2. Number of units completed and transferred to the next department.

3. Number of units remaining in process (Ending Work in Process).

4. State of Completion of the ending work in process.

 Cutting Department

Monthly Production Report

January 200X

Quantity

Started in Process – Current Month 12,880

Transferred Out to Next Department 9,120

Work in Process – Ending 3,760

Stage of Completion of Ending Work in Process

Materials 100%

Labor 40%

Overhead 55%

Equivalent Units of Production

Equivalent production is the measure of work done during the month, expressed in fully completed
units. There are units still in process at different stages of completion at the end of the month. All these
units must be converted to equivalent units of production by multiplying the number of units in process
by the percentage of completion. This procedure is necessary for the purpose of computing the unit
costs.¹

From the monthly production report of the Cutting Department, the equivalent production for each
element of cost is computed as shown:
 Cutting Department

Equivalent Production Computations

Month of January 200X

Materials

Transferred Out to Next Department 9,120

Work in Process – End (3,760 x 100%) 3,760

Equivalent Units for Materials 12, 880

Labor

Transferred Out to Next Department 9,120

Work in Process – End (3,760 x 40%) 1,504

Equivalent Units for Labor 10,624

Overhead

Transferred Out to Next Department 9,120

Work in Process – End (3,760 x 55%) 2,068

Equivalent Units for Overhead 11,188

Cost of Production Report – Cutting Department

The cost of production report to Star Company’s Cutting Department is shown below. The report
contains two sections: The quantity Schedule and the Cost Schedule.

Cutting Department

Cost of Production Report

Month of January 200X

Quantity Schedule Units

a. Quantity to Be Accounted For:

Started in Process 12,880

Total to be accounted for 12,880

b. Quantity Accounted For:

Transferred Out to Next Dept. 9,120

Work in Process – end 3,760

Total accounted for 12,880

Equivalent Unit

Cost Schedule Total Cost Units Costs

c. Costs to Be Accounted For:

Materials P 77,280 / 12,880 = P 6.00

Labor 95,616 / 10,624 = 9.00

Overhead 156, 632 / 11, 188 = 14.00

Total Costs to be accounted for P 329, 528 P29.00

 d. Costs Accounted For:

Transferred Out P264,480 = 9,120 x P29.00

Work in Process – End

Materials P 22,560 = 3,760 x 6.00

Labor 13,536 = 1,504 x 9.00

Overhead 28,952 = 2,068 x 14.00

Total Work in Process P 65,048

Total Costs Accounted For P329,528

The following should be noted in the cost of production report for Cutting Department.

1. Quantity Schedule – The Quantity Schedule is divided into two parts. The first half, Quantity to
be Accounted For, shows the number and source of the units processed during the month.
Since January 200X is the first month of operation, production of all units was started during the
current month. The second half, Quantity Accounted For, shows what happened to the units
presented in the first half of the Quantity Schedule.

2. Cost Schedule – The first part of the Cost Schedule, Costs to be Accounted For, shows the total
cost for which an accounting must be made. It also shows the cost of each cost element per
equivalent unit of production and the total cost of each equivalent unit. The unit cost of each
element is computed by dividing the total cost of the element by the related equivalent units
shown on the departmental equivalent production report. After the unit cost for each of the
cost elements has been computed, the unit costs are added to find the total cost per equivalent
unit. The second part of the Cost Schedule, Costs Accounted For, shows the production costs of
the month. The total cost of the units completed and transferred out to the next department is
computed first. The unit cost computed in the first part of the Cost Schedule is multiplied by the
number of units transferred out from the Quantity Schedule. The next part of the Section, Work
in Process – End, shows the cost of the work remaining in process at the end of the month. The
unit cost for each cost element, is multiplied by the equivalent units of that cost element in the
ending work in process.
Assembly Department

The units completed in the Cutting Department are transferred to the Assembly Department for further
processing.

Cost Added in Current Month

The costs of materials, labor, and overhead accumulated in the Work in Process – Assembly Department
are shown below:

Materials P21,830

Labor 82,954

Overhead 69,856

Monthly Production Report

The second department in Star Paper Company’s production sequence is the Assembly Department.
The 9,120 units transferred out of the Cutting Department become the input for the Assembly
Department’s operations during the month. Of these units, 8,150 were completed and transferred to
finished goods and 970 were left in ending work in process. These units are shown in the Assembly
Department’s monthly production report, as follows:

Assembly Department

Monthly Production Report

January 200X

Quantity

Transferred In From Prior Department 9,120

Transferred Out 8,150

Work in Process – End 970

Stage of Completion of Ending Work in Process

Transferred in Cost 100%

Materials 60%

Labor 60%

Overhead 60%
Equivalent Units of Production

From the monthly production report of the Assembly Department, equivalent units of production must
be computed for the three elements of costs. Ending work in process consisted of 970 units which
contained an average of 60% materials, labor, and overhead from this department. The equivalent units
of production for the three elements of costs are presented below:

Assembly Department

Equivalent Production Computations

Month of January 200X

Materials

Transferred Out to Next Department 8,150

Work in Process – End (970 x 60%) 582

Equivalent Units for Materials 8,732

Labor

Transferred Out to Next Department 8,150

Work in Process – End (970 x 60%) 582

Equivalent Units for Labor 8,732

Overhead

Transferred Out to Next Department 8,150

Work in Process – End ( 970 x 60%) 582

Equivalent Units for Overhead 8,732

Cost of Production Report – Assembly Department

The costs accumulated in the account Work in Process – Assembly Department and equivalent unit of
production provide the data needed to prepare the cost of production report for this department. The
report is shown below.
 Assembly Department

Cost of Production Report

Month of January 200X

Quantity Schedule Units

a. Quantity to Be Accounted For:

Transferred In From Prior Dept. 9,120

Total to Be Accounted For 9,120

b. Quantity Accounted For:

Transferred Out to Next Dept. 8,150

Work in Process – End 970

Total Accounted For 9,120

Equivalent Unit

Cost Schedule Total Cost Units Costs

c. Costs to Be Accounted For:

Costs Transferred In P264,480 / 9,120 = P29.00

Costs Incurred in this Department

Materials 21,830 / 8,732 = 2.50

Labor 82,954 / 8,732 = 9.50

Overhead 69,856 / 8,732 = 8.00

Total Costs in this Department P174,640 P20.00

Total Costs to be Accounted For P439,120 P49.00

 d. Cost Accounted For:

Transferred Out P399,350 = 8,150 x P49.00

Costs Transferred In P 28,130 = 970 x 29.00

Costs Incurred in this Dept.

Materials 1,455 = 582 x 2.50

Labor 5,529 = 582 x 9.50

Overhead 4,656 = 582 x 8.00

Total Work in Process P 39,770

Total Costs Accounted For P439,120

Packaging Department

This is the last department, so the units completed in this department is transferred to finished goods.

Cost Added in Current Month

The cost of materials, labor, and overhead accumulated in the Work in Process – Packaging Department
during the month are as follows:

Materials P2,172

Labor 24,492

Overhead 14,596

Monthly Production Report

The 8,150 units transferred out of the Assembly Department were received in this department. Of these
units 5,430 were completed and transferred to finished goods and 2,720 were left in ending work in
process. These units and their stage of completion are shown in the following production report:
 Packaging Department

Monthly Production Report

January 200X

Quantity

Transferred In From Prior Department 8,150

Transferred Out to Finished Goods 5,430

Work in Process – End 2,720

Stage of Completion of Ending Work in Process

Transferred Out 100%

Materials 0%

Labor 20%

Overhead 15%

Equivalent Units of Production

Based on the monthly production report, equivalent units of production are computed below:

Packaging Department

Equivalent Production Computations

Month of January 200X

Materials

Transferred Out to Finished Goods 5,430

Work in Process – End (2,720 x 0%) 0

Equivalent Units for Materials 5,430

Labor

Transferred Out to Finished Goods 5,430

Work in Process – End (2,720 x 20%) 544

Equivalent Units for Labor 5,974

Overhead

Transferred Out to Finished Goods 5,430

Work in Process – End (2,720 x 15%) 408

Equivalent Units for Overhead 5,838

Cost of Production Report

The cost of production report for the Packaging Department is presented below:

Packaging Department

Cost of Production Report

Month of January 200X

Quantity Schedule Units

a. Quantity to Be Accounted For:

Transferred In 8,150

Total to Be Accounted For 8,150

b. Quantity Accounted For:

Transferred Out to Finished Goods 5,430

Work in Process – End 2,720

Total Accounted For 8,150

 Equivalent Unit

Cost Schedule Total Cost Units Costs

c. Costs to Be Accounted For:

Costs Transferred In P399,350 / 8,150 = P49.00

Costs Incurred in this Department

Materials 2,172 / 5,430 = .40

Labor 24,492 / 5,974 = 4.10

Overhead 14,596 / 5,838 = 2.50

Total Costs in this Department P 41, 260 P 7.00

Total Costs to Be Accounted For P440,610 P 56.00

d. Cost Accounted For:

Transferred Out to Finished Goods P 304,080 = 5,430 x P 56.00

Work in Process – End

Costs Transferred In P 133,280 = 2,720 x 49.00

Costs Incurred in this Dept.

Materials 0 = 0 x .40

Labor 2,230 = 544 x 4.10

Overhead 1,020 = 408 x 2.50

Total Work in Process P 136,530

Total Costs Accounted For P 440,610

Recording Manufacturing Operations

The journal entries for Star Paper Company to record manufacturing operations for the month of
January 200X are the following:

Cutting Department

1. To record cost incurred:

Work in Process – Cutting Department 329,528

Materials 77,280

Factory Payroll 95,616

Applied Manufacturing Overhead 156,632

To record costs incurred.

2. To record costs of completed units transferred to Assembly Department.

Work in Process – Assembly Department 264,480

Work in Process – Cutting Department 264,480

To record units transferred to Assembly Department.

Assembly Department

3. To record cost added:

Work in Process – Assembly Department 174,640

Materials 21,830

Factory Payroll 82,954

Applied Manufacturing Overhead 69,856

4. To record costs of units transferred to Packaging Department.

Work in Process – Packaging Department 399,350

Work in Process – Assembly Department 399,350

To record units transferred to Packaging Department.

Packaging Department

5. To record cost added in the current month:

Work In Process – Packaging Department 41,260

Materials 2,172

Factory Payroll 24,492

Applied Manufacturing Overhead 14,596

6. To record cost of completed units transferred to finished goods inventory.

Finished Goods 304,080

Work in Process – Packaging Department 304,080

The balances of the Departmental Work in Process on January 31, 200X are computed below:

Cutting Assembly Packaging

Materials P 77,280 P 21,830 P 2,172

Labor 95,616 82,954 24,492

Overhead 156,632 69,856 14,596

Total costs incurred 329,528 174,640 41,260

Transferred In - 264,480 399,350

Transferred Out (264,480) (399,350) (304,080)

Balance – January 31 P 65,048 P39,770 P 136,530

Recording Sales and Cost of Goods Sold

Assume that 5,300 units were sold during January for P80 each, for a total selling price of P424,000.
Since this is the first month of operation of Star Paper Company, all the units sold came from January
production. The 5,300 units sold had a total cost of P296,800 (5,300 x P56). Entries to record sales and
cost of sales during January are presented as follows:

Jan. 31: Accounts Receivable 424,000

Sales 424,000

To record sales during January.

Cost of Goods sold 296,800

Finished Goods 296,800

To record cost of units sold during January.

SOURCE AND REFERENCE:

Pedro P. Guerrero, Cost Accounting – Principles and Procedural Applications, 2018 Edition