Chapter 06 – Process Costing
Chapter 6
Process Costing
Learning Objectives
1. Identify the types of firms or operations for which a process costing system best supports the
organization’s competitive strategy
2. Explain and calculate equivalent units
3. Describe the five steps in process costing
4. Demonstrate the weighted-average method of process costing
5. Demonstrate the FIFO method of process costing
6. Analyze process costing with multiple departments
7. Prepare journal entries to record the flow of costs in a process costing system
8. Explain how process costing systems are implemented and enhanced in practice
9. Account for spoilage in process costing
New in this edition
Cost Management in Action element revised and updated
Large text exhibits revised to fit each on one page
Ten revised exercises and problems
Teaching Suggestions
Following on the introduction to cost systems in Chapter 4 and the adaption of cost systems to ABC
costing in chapter 5, this chapter explains the business context in which the process costing method is used.
Additionally, the procedural aspects of the method are carefully developed. Several actual examples are used to
demonstrate how the method fits different operating conditions.
We have covered this topic in one or two days. When we use one day, we focus on the determination of
equivalent units and go through a couple of illustrations and exercises. We also explain what types of firms use
process costing. We will normally cover both the FIFO and the weighted average methods. When we use two
days, we cover the case of two or more departments and the different types of spoilage on the second-class day.
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Chapter 06 – Process Costing
Assignment Matrix Chapter 6
Exercises and Problems
Learning Objectives Text Features
7e 6e Transition
6e to 7e
Time
Connect
1.
Where process costing is appropriate
2.
Equivalent units
3.
Five steps in process costing
4.
Weighted average method
5.
FIFO method
6.
Process costing with multiple departments
7.
Flow of costs, Journal entries
8.
Implementation; A BC, Backflush costing
9.
Spoilage (appendix)
Strategy
Service
International
Ethics
Sustainability
Brief Exercises
6-18 6-18 X X
6-19 6-19 X X
6-20 6-20 X X
6-21 6-21 X X
6-22 6-22 X X
6-23 6-23 X X
6-24 6-24 X X
6-25 6-25 X X
6-26 6-26 X X
Exercises
6-27 6-27 10 min. X
6-28 6-28 15 min. X X X X
6-29 6-29 20 min. X X X X X X X X X
6-30 6-30 20 min. X X X
6-31 6-31 25 min. X X X X
6-32 6-32 25 min. X X X X
6-33 6-33 20 min. X X X
6-34 6-34 25 min. X X X X X
6-35 6-35 25 min. X X X X X
Problems
6-36 6-36 Revised 25 min. X X
6-37 6-37 20 min. X X
6-38 6-38 20 min. X X
6-39 6-39 Revised 30 min. X X
6-40 6-40 Revised 30 min. X X X
6-41 6-41 Revised 25 min. X X X X
6-42 6-42 20 min. X X X X
6-43 6-43 Revised 25 min. X X X X
6-44 6-44 25 min. X X X X
6-45 6-45 40 min. X X X
6-46 6-46 60 min. X X X
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Chapter 06 – Process Costing
Continued on next page…
Assignment Matrix Chapter 6
(continued)
Learning Objectives Text Features
7e 6e Transition
6e to 7e Time
Connect
1.
Where process costing is appropriate
2.
Equivalent units
3.
Five steps in process costing
4.
Weighted average method
5.
FIFO method
6.
Process costing with multiple departments
7.
Flow of costs, Journal entries
8.
Implementation; A BC, Backflush costing
9.
Spoilage (appendix)
Strategy
Service
International
Ethics
Sustainability
Problems (continued)
6-47 6-47 Revised 60 min. X X X
6-48 6-48 Revised 50 min. X X X X X X X
6-49 6-49 40 min. X X X X
6-50 6-50 Revised 40 min. X X X X X
6-51 6-51 30 min. X X X X
6-52 6-52 25 min. X X X X
6-53 6-53 Revised 10 min. X
Lecture Notes
A. Strategic Role of Process Costing. Process costing is a product cost system wherein costs are
accumulated in processing departments and then allocated to all units processed during the period, including both
completed and partially completed units. It is used by firms producing homogeneous products on a continuous
basis, to assign manufacturing costs to units in production during the period. Firms that use process costing
include paint, chemical, oil refining, and food processing companies.
Process costing systems provide information for managers to make strategic decisions regarding choice of
products and customers, manufacturing methods, pricing decisions, and other long term issues.
B. When Should a Process Costing System Be Used? Firms having homogeneous products, which pass
through a series of similar processes or departments, use process costing. These firms usually engage in
continuous mass production of a few similar products. The work done by the production departments or processes
does not vary because all the units are essentially the same. Manufacturing costs are accumulated in each process.
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Chapter 06 – Process Costing
The departmental production cost report is a key document to keep track of production quantity and cost
information. Unit product cost is calculated by dividing process costs in each department by the equivalent units
produced during the period. Process cost systems are used in many industries such as chemicals, oil refining,
textiles, paints, flour, canneries, rubber, steel, glass, food processing, mining, automobile production lines,
electronics, plastics, drugs, paper, lumber, leather goods, metal products, sporting goods, cement and watches.
Process costing can also be used by service organizations with homogeneous services and repetitive processes
such as check processing in a bank or mail sorting in a courier.
C. Equivalent Units. Equivalent units are the number of like or similar completed units that could have been
produced given the amount of work actually performed on both completed and partially completed units.
Equivalent units are not the same as physical units. A firm produced 30 television sets last month with 20
completed sets and 10 partially completed sets (roughly 50% complete). The physical units were 30 sets. But
equivalent units were only 25 sets [20 + (10 x 50%)].
D. Five Steps in Process Costing. The key document in a typical process costing system is the production
cost report, which summarizes the physical units, and equivalent units of a department, the costs incurred during
the period, and costs assigned to both completed goods and transferred out and to ending work in process
inventories. The preparation of a production cost report includes five steps: (1) analysis of physical units, (2)
calculation of equivalent units, (3) determination of total costs to account for, (4) computation of unit costs, and
(5) assignment of total costs.
E. Weighted Average Method vs. FIFO Method. There are two methods of preparing the departmental
production cost report in process costing practices: (1) weighted average method, and (2) first-in, first-out method
(FIFO). The weighted average method includes all costs, both those incurred the current period and those
incurred in the prior period that are shown as the beginning work in process inventory of this period, in
calculating the unit cost. The FIFO method includes only costs incurred during the current period in calculating
equivalent unit cost. It considers the beginning inventory as a batch of goods separate from the goods started and
completed within the same period. FIFO assumes that all the beginning work in process inventories were
completed first before other work is done during the current period.
Under the weighted-average method, it makes no difference when a product is started; all units completed in the
same period are treated the same. When this method is used, all you have to know is the status of the product at
the end of the period. On the other hand, both the status of the product at the end of a period and at the beginning
of a period have to be taken into consideration when the FIFO method is used in determining product costs. That
is, the FIFO method looks at input as well as output of the production, whereas the weighted-average method
looks at only the output of the production.
F. Process Costing with Multiple Departments. Most manufacturing firms have several departments or
use processes that require several steps. As the product passes from one department to another, the cost has to
follow. The costs come from the prior department are called transferred-in costs or prior department costs.
Process costing with multiple departments should include the transferred-in cost as the fourth cost element in
addition to direct materials, direct labor, and factory overhead costs.
G. Flow of Costs in a Process Costing. Process costing uses the same manufacturing accounts as job
costing discussed in the preceding chapter. Journal entries are essentially the same as in job costing. However,
instead of tracing product costs to specific jobs, we accumulate costs in production departments or cost centers.
H. Implementation and Enhancement of Process Costing. For firms who adopt either just-in-time or
flexible manufacturing systems, the choice between the weighted-average or the FIFO method of process costing
becomes not so important because the new system reduces inventory units. These firms may use a simplified
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Chapter 06 – Process Costing
costing system called backflush costing which is a method that charges current production costs directly to
finished goods inventory without accounting for the flows in and out of work-in-process.
While process costing is generally applied in contexts where there are one or a few homogeneous
products, there are often cases wherein two or more products share production facilities and use the activities of
these facilities at different rates. In these cases, ABC costing can prove to be valuable. An example is provided in
the text of a chemical that uses both ABC and process costing.
I. Spoilage in Process Costing. There are two types of spoilage: normal spoilage and abnormal spoilage.
Normal spoilage is what occurs under efficient operating conditions. It is uncontrollable in the short-term and is
considered a part of product cost. That is, the good units produced absorb lost unit costs. Abnormal spoilage is
that in excess of that expected under efficient operating conditions, and is charged as a loss to operations in the
period detected.
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