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Chapter 6 - Process Costing
Chapter 6
Process Costing
Teaching Notes for Cases and Articles
Teaching Notes For Cases
6-1. The Rossford Plant (Two Production Processes with the Traditional
Volume-Based Costing System)
The Rossford Plant case focuses on issues of cost system design in the plant, which produces
similar products with very differently arranged production processes. This case concerns product costing
at Rossford for pricing, product mix, and production scheduling decisions.
Libbey-Owens-Ford Co. (L-O-F) treats Rossford as a standard cost center. A centralized
management group decides what products Rossford and six other fabricating plants will produce, when
the products will be produced, and what their selling prices will be. The plants’ managements are
responsible for meeting production and standard cost goals. In this setting, inaccurate costs reported to the
central planning group could result in poor decisions concerning the use of plant capacity.
The product mix assigned to the Rossford Plant led its managers to suspect that their product
costing system was inaccurate. The system undercosted some small units requiring extensive heating and
bending, and Rossford was therefore assigned a disproportionately large share of those difficult pieces.
Because the units consumed more resources than charged by the system, the total plant costs were
typically higher than budgeted. This is the primary evidence of inaccurate allocation referred to in the
case.
You may find that your students want to spend a large amount of time trying to “check” the
general plant allocations given in Figure 3. This is a frustrating experience, because data such as the feed
rates and the yield rates of the four lites are not given. The objective of the questions is to focus their
attention on the cost system design issues that are the heart of the case.
Source: 1989 IMA Cases from Management Accounting Practice, Volume 5, Case 1.
Suggested Answers to Questions
1. The nominal cost object both before and after the change is the individual unit of glass, or lite.
However, the pre-change cost object is more accurately regarded as the bundle of front window, rear
window, side windows, and side vents. The costing system change was motivated in part by the two
Controllers’ desire to change the cost object to the individual lite.
Prior to the change, Rossford’s managers believed that the unit costs of individual pieces were
inaccurate but that inaccuracies within a bundle offset each other because of the differences in the
lites that comprise the bundle. If this belief were true, then the total costs of bundles were accurate
enough to be used in bundle selling prices. However, the prospect of selling individual lites made
these unit cost inaccuracies unacceptable for pricing.
Even without the prospective change in sales unit, though, accurate individual unit cost information is
necessary for good product mix and production scheduling by the central planning group. As
mentioned above, unit cost information is used to assign production of specific lites to specific plants.
The central group needs to know the demands each unit makes on the scarce or capacity resources of
each plant so that it may schedule production to maximize profit margins per unit of scarce resources
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Chapter 6 - Process Costing
consumed. MacGuidwin and Lackner therefore needed to find a better method to trace the plant’s
costs to products.
2. A good product costing system provides accurate estimates of the long-run variable costs of all the
demands made on the organization’s resources by each product in its product line. These costs include
the costs of raw materials and purchased components and the costs of raw materials and purchased
components and the costs of factory resources consumed to market, distribute, and service the
product; and the overhead costs of support services such as those classified as “general plant” by the
Rossford management. To accurately trace these overhead costs, the system should not only include
traditional volume-based measures, such as Rossford’s equipment hours, but also measures of
activities, which drive specific indirect costs. These measures could include a number of setups,
number of inspections, number of orders received, number of shipments made, and number of
engineering change orders, among many others.
A good system provides timely and cost-efficient information to users. The timeliness issue is not as
critical for product costing as for process control. However, the system should be reviewed
periodically and when major changes are made in process technology, product mix, or organizational
structure. Also, the expected benefits of more accurate tracing of costs should exceed the additional
costs of achieving that accuracy (for example, the costs of determining and measuring additional cost
drivers).
3. Fabricating operations of the Rossford plant are organized by equipment center—lines of machines in
Pattern Cutting and Edging and furnaces in Tempering. The cost accounting system facilitates process
control at the equipment center level by distinguishing between directly traceable and indirect
overhead items and assigning all direct conversion costs to specific equipment centers. The system
allows the plant management to satisfy organizational requirements to determine responsibility for
specific standard cost variances at the equipment center level.
Rossford’s product costing system is typical in that many conversion costs are first traced to cost
centers for control purposes and then allocated to units of product. There are no direct product costs in
this system. Direct labor and some overhead costs are accumulated at the machine or furnace cost
center level; general plant overhead costs are accumulated at the aggregate level of the entire plant.
All of these costs are allocated to products on standard feed rate bases in the post-change system.
4. The primary factor that motivated the Corporate and Plant Controllers to change the allocation
method for general plant costs was their perceived need for more accurate tracing of these costs to
units of product. They realized the old method of allocation did not reflect the demands each product
made on the plant’s resources. The question is whether use of the new method results in a more
accurate assignment of the costs of those demands.
Maximum accuracy would require the decomposition of the general plant cost pool into smaller
homogenous cost pools in which a single cost driver could explain cost variations. The cost per unit
of each driver in each pool could then be used to assign the pool’s costs to units of product.
Mark MacGuidwin chose to leave intact the large cost pool and allocate it based on tempering furnace
feed rates. Rossford’s managers believe that the most important driver of the general plant overhead
costs is the need to inventory units so that furnaces can operate continuously. Because furnace start-
ups and shutdowns are very costly, units that have been cut and edged are inventoried to prevent
them. The managers believe that many of the general plant costs are driven by the need to store, track,
move, and otherwise service the work-in-process inventories.
In MacGuidwin’s opinion, the product costs allocated by the new system approximate the costs that
would be assigned by a more disaggregated (and costly) system of homogenate cost pools. This is
debatable, as is the question of whether the new system is a substantial improvement over the old.
However, the new system does reveal products’ demands on the most scarce resource in the facility—
tempering furnace capacity. Also, its results more closely approximate the beliefs of the Engineering
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Chapter 6 - Process Costing
and Manufacturing Vice Presidents concerning general plant cost incurrence. And finally, it is no
more costly to operate than the old system, requiring no additional measurement of production or
service activities.
6-2. The United L/N Plant (Scrap and Defects)
The United L/N Plant case explores issues of product costing system design that arose at the glass
fabrication plant of the Libbey-Owens-Ford Co. (L-O-F). This case demonstrates that changes in a plant’s
production operations may necessitate changes in its product costing system. In particular, it focuses on
the costs and benefits of determining the causes of product defects in a fully automated, in-line production
setting.
The primary problem at the United L/N plant is that its yield is substantially lower than budgeted.
The higher than anticipated scrap rate makes it difficult for the plant to meet profit goals set by its join L-
O-F and Nippon Sheet Glass board of directors.
If Rossford and United L/N were independent companies, they could negotiate a market price for
raw glass, incorporating the risk of bad glass into the contract. If L-O-F were to make Rossford a profit
center instead of a cost center, the two managements could similarly negotiate a transfer price.
Additionally, if the two managements were given decentralized decision-making authority, they could
decide whether to sell to and buy from each other.
However, the L-O-F management is very wary of decentralization. The company has a tradition
of centralized control. Senior executives do not want to change Rossford’s status either as a standard cost
center or as a supplier of United L/N. The two plants’ managements were therefore instructed to work out
a mutually agreeable solution to their dispute, which centers on disposition of the United L/N scrap
variance.
Source: 1989 IMA Cases from Management Accounting Practice, Volume 5, Case 2.
Answers to Questions
1. At the Rossford Plant, experienced personnel inspect glass after each operation and when units are
finished. These inspectors strongly believe that the problems with yields at United L/N are caused by
problems with the plant’s automated machines and the inability of its personnel both to properly set
the dials, which control the machines, and to otherwise operate the equipment. This belief is
reinforced by an unsubstantiated rumor that the yield rate of one of the three United L/N shifts is
much higher than that of the other two.
Rossford’s management initially argued that the plant should be charged only the Rossford
manufacturing cost (transfer price to United L/N) of units that are scrapped because of defects in the
raw glass that it transfers. This solution would require identification of the specific causes of scrap at
United L/N, which would further require changes in the plant’s production lines. The United L/N
position is that inspection at Rossford is insufficient to detect all defects and, as discussed in the case,
2. To improve its yield and its profit performance, United L/N’s management must determine and
correct the problems that are causing excessive amounts of scrap in the plant’s production process.
The problems could include bad glass, flaws in the automated equipment, and improper operation of
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Chapter 6 - Process Costing
the equipment by plant technicians. Determining where units become defective necessarily precedes
determining why they become defective.
To answer the “where” question, United L/N’s personnel could (1) rigorously inspect raw glass
received from Rossford and other shipping plants to practically eliminate bad glass as a cause of
defects, and (2) install and operate monitoring equipment after each stage of the production process.
If successful, these steps could considerably reduce the disputes between United L/N and its
suppliers. In fact, in the plants’ negotiations Rossford personnel have pushed hard for installation of
such equipment. However, inspection of raw glass is not an “exact science,” and United L/N
managers could continue to argue that some defects detected in processing were caused by bad glass.
Operation of the monitoring equipment would create a situation similar to that of the Rossford plant,
where units are visually inspected after each discrete processing step. Idle work-in-process inventory
would accumulate at each monitoring station. As the number of units in inventory increased, so would
3. One solution to the problem would be to install accumulators in front of the furnaces so that they
could be kept filled to optimal levels at all times. The effects of this action would be similar to the
effects of installing monitoring equipment as discussed above. Idle work-in-process inventory would
be introduced in production lines that were designed specifically to function without it, and inventory
support costs would increase with the size of the inventory. Furthermore, separating each of the two
lines at the furnace could eventually lead to different feed rates to the pattern cutting and edging
operations than to the furnace. It could also lead to separate managerial responsibility for the two
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6-3. Downstream Brewery (B)
OVERVIEW AND OBJECTIVES OF THE CASE
This case is written to cause students to design a simple process costing system. It forces students
to think through on their own how such system operates and what the output of such system should be.
The case is best used as an introduction to chapter on process costing in a cost or managerial accounting
course (either introductory or second courses in a sequence). Analyzing the case before discussing the
materials in a textbook provides an excellent opportunity to let students demonstrate to themselves that
the underlying principles involved in these topics are more straightforward than the treatment in many
textbooks would indicate. Students are asked to “do what makes sense” to them, then to see what the text
or instructor suggest as enhancements. A suggested schedule is provided, followed by detailed notes on
each part of the case materials.
Suggested Schedule
Day Activity
Process-1 Assign the case reading and briefly discuss “Sticking Points” at
the end of the class session before the first day on a chapter about
process costing.
Process-2 Discuss full solution in light of text reading and other materials
selected.
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STICKING POINTS
1. Have students think about the problem using three separate production departments (Boiling, Fermenting and
Shipping). Through class discussion develop the idea that in order to calculate the costs per unit, students will
need to determine two sets of quantities: the equivalent units and costs incurred relating to each department.
Elicit students’ intuitions about what equivalent units represent and why the estimation of equivalent units is
necessary.
2. Be sure students understand that equivalent units of direct materials, conversion costs (direct labor and
overhead), and prior department if any may be produced at different rates. This requires separate tracking of
these items.
3. Distinguish process costing from job costing systems by having students think back to “Getting Things
Flowing” where they made entries for all inputs by contract (job), rather than by equivalent units.
4. Students will need to think about how the process works in order to determine which can be considered direct
costs, and which should be considered indirect costs. They will need to do the same thing to determine what
share of labor and overhead dollars go with each of the three processes. For demonstration purposes, we once
again track all inputs separately, but students can easily see the merits of using allocated overhead from larger
cost pools.
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