Job-order costing and process costing are two common methods for determining

unit product costs.

Job-order costing process costing
job-order costing is used when many different jobs process costing is used most commonly in industries
or products are worked on each period. that convert raw materials into homogeneous
Examples: Examples
furniture manufacturing, aluminum ingots,
special-order printing, toilet paper
shipbuilding, and flour
many types of service organizations. gasoline
sunscreens
breakfast cereals
utilities that produce gas, water, and electricity.
Similarities between Job-Order and Process Costing
1. Both systems have the same basic purposes:
to assign material, labor, and manufacturing overhead costs to products and
to provide a mechanism for computing unit product costs.
2. Both systems use the same basic manufacturing accounts, including
Manufacturing Overhead,
Raw Materials,
Work in Process, and
Finished Goods.
3. The flow of costs through the manufacturing accounts is basically the same in both
systems.
Differences between Job-Order and Process Costing
1. Many different jobs are worked on during each 1. A single product is produced either on a continuous
period, with each job having different production basis or for long periods of time. All units of product
requirements. are identical.
2. Costs are accumulated by individual job. 2. Costs are accumulated by department.
3. Unit costs are computed by job on the job cost sheet. 3. Unit costs are computed by department.

What is manufacturing costs flow through a process costing system?

Processing Departments
A processing department is an organizational unit where work is performed on a product
and where materials, labor, or overhead costs are added to the product.

Examples of processing departments as: preparing food, one for cooking, and one for inspecting and
packaging.
Some products and services may go through a number of processing departments, while others may go through
only one or two but typically has flow in sequence from one department to another.

Processing departments have two essential features:

1. The activity in the processing department is performed uniformly on all of the units passing through it.
2. The output of the processing department is homogeneous; in other words, all of the units produced are
identical.
The Flow of Materials, Labor, and Overhead Costs
Cost accumulation is simpler in a process costing system than in a job-order costing system.
In a process costing system, instead of having to trace costs to hundreds of different jobs, costs are traced to
only a few processing departments.
First, note that a separate Work in Process account is maintained for each processing department.
In contrast, in a job-order costing system the entire company may have only one Work in Process account.

Second, note that the completed production of the first processing department (Department A in the exhibit) is
transferred to the Work in Process account of the second processing department (Department B). After
further work in Department B, the completed units are then transferred to Finished Goods. (In Exhibit 4–3 , we
show only two processing departments, but a company can have many processing departments.)

Finally, note that materials, labor, and overhead costs can be added in any processing department—not just the
first.
Costs in Department B’s Work in Process account consist of the materials, labor, and overhead costs incurred
in Department B plus the costs attached to partially completed units transferred in from Department A (called
transferred-in costs).

Materials, Labor, and Overhead Cost Entries

1. Materials Costs Materials can be added in any processing department, although it is not unusual for
materials to be added only in the first processing department, with subsequent departments adding only
labor and overhead costs.
At Megan’s Classic Cream Soda, some materials (i.e., water, flavors, sugar, and carbon dioxide) are added in
the Formulating Department and some materials (i.e., bottles, caps, and packing materials) are added in the
Bottling Department.
The journal entry to record the materials used in the first processing department, the Formulating Department,
is as follows:

Work in Process—Formulating . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX

Raw Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX
The journal entry to record the materials used in the second processing department, the
Bottling Department, is as follows:
Work in Process—Bottling . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX
Raw Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX

2. Labor Costs In process costing, labor costs are traced to departments—not to individual jobs. The
following journal entry records the labor costs in the Formulating Department at Megan’s Classic Cream
Soda:

Work in Process—Formulating . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX

Salaries and Wages Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX
A similar entry would be made to record labor costs in the Bottling Department.

3. Overhead Costs In process costing, as in job-order costing, predetermined overhead rates are usually
used. Manufacturing overhead cost is applied according to the amount of the allocation base that is
incurred in the department. The following journal entry records the overhead cost applied in the
Formulating Department:
Work in Process—Formulating . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX
Manufacturing Overhead. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX

A similar entry would be made to apply manufacturing overhead costs in the Bottling Department.

4. Completing the Cost Flows Once processing has been completed in a department, the units are
transferred to the next department for further processing, as illustrated in the T-accounts in Exhibit 4–3 .
The following journal entry transfers the cost of partially completed units from the Formulating
Department to the Bottling Department:

Work in Process—Bottling . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX

Work in Process—Formulating . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX

After processing has been completed in the Bottling Department, the costs of the completed units are
transferred to the Finished Goods inventory account:

Finished Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX

Work in Process—Bottling. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX

Finally, when a customer’s order is filled and units are sold, the cost of the units is transferred to Cost of
Goods Sold:

Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX

Finished Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX

To summarize, the cost flows between accounts are basically the same in a process costing system as they are
in a job-order costing system. The only difference at this point is that in a process costing system each
department has a separate Work in Process account.

Equivalent Units of Production

After materials, labor, and overhead costs have been accumulated in a department, the department’s output
must be determined so that unit product costs can be computed. The difficulty is that a department usually has
some partially completed units in its ending inventory. It does not seem reasonable to count these partially
completed units as equivalent to fully completed units when counting the department’s output. Therefore, these
partially completed units are translated into an equivalent number of fully completed units. In process costing,
this translation is done using the following formula:

Equivalent units = Number of partially completed units x Percentage completion

500 units in ending work in process inventory that are 60% complete with respect to processing in the
department. These 500 partially complete units are equivalent to 300 fully complete units (500 x 60% = 300).

Therefore, the ending work in process inventory contains 300 equivalent units. These equivalent units are
added to any units completed during the period to determine the department’s output for the period—called the
equivalent units of production.

Equivalent units of production for a period can be computed in different ways.

- Weighted-average method blends together units and costs from the current period with units and costs
from the prior period. In the weighted-average method, the equivalent units of production for a
department are the number of units transferred to the next department (or to finished goods) plus the
equivalent units in the department’s ending work in process inventory.
- FIFO method of process costing is a method in which equivalent units and unit costs relate only to
work done during the current period.

Weighted-Average Method
Under the weighted-average method, a department’s equivalent units are computed as
follows:

equivalent units of production = (the number of units transferred out of the department) + (the equivalent units
in the department’s ending inventory)

the number of units transferred out of the department:

There is no need to compute the equivalent units for the units transferred out of the department—they are
100% complete with respect to the work done in that department or they would not be transferred out.

Conversion cost: is direct labor cost plus manufacturing overhead cost.

Note that the computations ignore the fact that the units in the beginning work in process inventory were
partially complete.
For example, the 200 units in beginning inventory were already 30% complete with respect to conversion
costs. Nevertheless, the weighted-average method is concerned only with the 4,900 equivalent units that are
in ending inventories and in units transferred to the next department; it is not concerned with the fact that the
beginning inventory was already partially complete.
In other words, the 4,900 equivalent units computed using the weighted-average method include work that was
accomplished in prior periods. This is a key point concerning the weighted-average method and it is easy to
overlook.

We computed the equivalent units of production for materials and for conversion.
We will compute the cost per equivalent unit for materials and for conversion.
We will then use these costs to value ending work in process and finished goods inventories.

Cost per Equivalent Unit—Weighted-Average Method

Note that the numerator is the sum of the cost of beginning work in process inventory and of the cost added
during the period. Thus, the weighted-average method blends together costs from the prior and current periods.

That is why it is called the weighted-average method; it averages together units and costs from both the prior
and current periods.
The costs per equivalent unit for materials and for conversion are computed below
for the Shaping and Milling Department for May:
The costs per equivalent unit are used to value units in ending inventory and units that are transferred to the
next department.

Each unit transferred out of Double Diamond’s Shaping and Milling Department to the Graphics Application
Department will carry with it a cost of $149.00
($76.25 for materials cost and $72.75 for conversion cost).

Because 4,800 units were transferred out in May to the next department, the total cost assigned to those units
would be $715,200 ( =4,800 units x $149.00 per unit).

Cost Reconciliation Report

The costs assigned to ending work in process inventory and to the units transferred out reconcile with the costs
we started with in Exhibit 4–7 as shown below:

The $715,200 cost of the units transferred to the next department, Graphics Application, will be accounted for
in that department as “costs transferred in.”
It will be treated in the process costing system as just another category of costs like materials or conversion
costs.
The only difference is that the costs transferred in will always be 100% complete with respect to the work done
in the Graphics Applications Department. Costs are passed
on from one department to the next in this fashion, until they reach the last processing
department, Finishing and Pairing. When the products are completed in this last department,
their costs are transferred to finished goods.

The costing systems discussed in Chapters 3 and 4 represent the two ends of a continuum.
On one end is job-order costing, which is used by companies that produce many different products in one
facility.
On the other end is process costing, which is used by companies that produce homogeneous products in large
quantities.
Between these two extremes there are many hybrid systems that include characteristics of both job-order and
process costing. One of these hybrids is called operation costing.
Operation costing is used in situations where products have some common characteristics and some individual
characteristics.
Shoes, for example, have common characteristics in that all styles involve cutting and sewing that can be done
on a repetitive basis, using the same equipment and following the same basic procedures.
Shoes also have individual characteristics—some are made of expensive leathers and others may be made
using inexpensive synthetic materials.
In a situation such as this, where products have some common characteristics but also must be processed
individually, operation costing may be used to determine product costs.
As mentioned above, operation costing is a hybrid system that employs aspects of both job-order and process
costing.
Products are typically processed in batches when operation costing is used, with each batch charged for its own
specific materials. In this sense, operation costing is similar to job-order costing. However, labor and overhead
costs are accumulated by operation or by department, and these costs are assigned to
units as in process costing. If shoes are being produced, each shoe is charged the same
per unit conversion cost, regardless of the style involved, but it is charged with its specific
materials cost. Thus, the company is able to distinguish between styles in terms of
materials, but it is able to employ the simplicity of a process costing system for labor and
overhead costs.

Examples of other products for which operation costing may be used include electronic
equipment (such as semiconductors), textiles, clothing, and jewelry (such as rings,
bracelets, and medallions). Products of this type are typically produced in batches, but
they can vary considerably from model to model or from style to style in terms of the cost
of materials.