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Chapter 4 Process Costing
1
Chapter 4
Lecture Notes
Chapter theme: Managers need to assign costs to products
to facilitate external financial reporting and internal
decision making. This chapter illustrates an absorption
costing approach to calculating product costs known as
process costing.
I. Comparison of job-order and process costing
A. Similarities between job-order and process costing
i. Both systems assign material, labor, and
overhead costs to products and they provide a
mechanism for computing unit product costs.
ii. Both systems use the same manufacturing accounts,
including Raw Materials, Work in Process,
Manufacturing Overhead, and Finished Goods.
iii. The flow of costs through the manufacturing
accounts is basically the same in both systems.
B. Differences between job-order and process costing
i. Process costing is used when a single product is
produced on a continuing basis or for a long period
of time. Job-order costing is used when many
different jobs having different production
requirements are worked on each period.
ii. Process costing systems accumulate costs by
department and assign them uniformly to all units
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Chapter 4 Process Costing
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processed during the period. Job-order costing
systems accumulate costs by individual jobs.
iii. Process costing systems compute unit costs by
department. Job-order costing systems compute
unit costs by job on the job cost sheet.
Quick Check
−
process vs. job-order costing
II. Cost flows in process costing
A. Processing departments − An organizational unit
where materials, labor, or overhead costs are added to
the product.
i. The activity performed in a processing department
is performed uniformly on all units passing
through it. Furthermore, the output of a processing
department must be homogeneous.
ii. Products in a process costing environment typically
flow in a sequence from one department to
another.
Learning Objective 4-1: Record the flow of materials,
labor, and overhead through a process costing system.
B. The flow of materials, labor, and overhead costs
i. The flow of costs through the manufacturing
accounts is basically the same for process and job-
order costing.
1. Direct materials, direct labor, and
manufacturing overhead are added to Work
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Chapter 4 Process Costing
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in Process. When work in process is
completed, the costs are transferred to
Finished Goods. When finished goods are
sold, the costs are transferred to Cost of
Goods Sold.
ii. Nonetheless, there is a key fundamental
difference between process and job-order costing
systems.
1. Job-order costing systems trace and apply
manufacturing costs to jobs.
a. One Work in Process account is often
used to accumulate costs for all jobs.
The individual job cost sheets serve
as a subsidiary ledger.
2. Process costing systems trace and apply
manufacturing costs to departments.
a. A separate Work in Process account
is maintained for each processing
department.
b. Material, labor, and overhead costs
transferred from one department’s
Work in Process account to another
department’s Work in Process
account are called transferred-in
costs.
iii. T-account and journal entry views of process
cost flows (For purposes of this example, assume
there are two processing departments—A and B).
Helpful Hint: Explain that the journal entries for job-
order and process costing are similar, with the
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exception of the specific Work in Process account for
each department under process costing.
1. The flow of raw material costs.
a. In T-account form:
(1). Direct material costs are debited
to the appropriate departmental
Work in Process account
depending upon where the
materials were added to the
production process. The Raw
Materials account is credited for
the corresponding amounts.
b. In journal entry form:
(1). Debit the respective
departmental Work in Process
accounts. Credit Raw Materials.
2. The flow of labor costs.
a. In T-account form:
(1). Direct labor costs are debited to
the appropriate departmental
Work in Process account
depending upon where the labor
was added to the production
process. Salaries and Wages
Payable is credited for the
corresponding amounts.
b. In journal entry form:
(1). Debit the respective
departmental Work in Process
accounts. Credit Salaries and
Wages Payable.
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3. The flow of manufacturing overhead
costs.
a. In T-account form:
(1). Manufacturing overhead costs
are debited to the respective
departmental Work in Process
accounts. Manufacturing
Overhead is credited by the
corresponding amounts.
(a). Predetermined overhead
rates are usually used to
apply overhead to the
departments.
b. In journal entry form:
(1). Debit the appropriate
departmental Work in Process
accounts. Credit Manufacturing
Overhead.
4. The flow of manufacturing costs for
partially completed units transferred from
Department A to Department B:
a. In T-account form:
(1). The cost of direct materials,
direct labor, and manufacturing
overhead assigned to partially
completed units from
Department A is debited to
Department B and credited to
Department A.
(2). The transferred-in costs from
Department A are added to the
manufacturing costs incurred in
Department B.
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b. In journal entry form:
(1). Debit Work in Process −
Department B and credit Work
in Process − Department A.
5. The flow of manufacturing costs from the
final processing department to finished
goods.
a. In T-account form:
(1). Debit Finished Goods and credit
Work in Process − Department
B for the amount of the cost of
goods manufactured.
b. In journal entry form:
(1). Debit Finished Goods and credit
Work in Process − Department
B.
6. The flow of manufacturing costs from
Finished Goods to Cost of Goods Sold.
a. In T-account form:
(1). Debit Cost of Goods Sold and
credit Finished Goods.
b. In journal entry form:
(1). Debit Cost of Goods Sold and
credit Finished Goods.
III. Equivalent units of production
A. Equivalent units − are defined as the product of the
number of partially completed units and the percentage
completion of those units.
i. Equivalent units need to be calculated because a
department usually has some partially completed
units in its beginning and ending inventories. These
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Chapter 4 Process Costing
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partially completed units complicate the
determination of a department’s output for a given
period and the unit cost that should be assigned to
that output.
Helpful Hint: Explain that equivalent units simply
restate the ending work in process inventory as if it
were comprised of a smaller number of fully completed
units.
ii. Equivalent units − the basic idea.
1. Two half completed products are equivalent
to one complete product.
2. 10,000 units 70% completed are equivalent
to 7,000 complete units.
Quick Check
−
calculating equivalent units
iii. Equivalent units can be calculated two ways.
1. The FIFO method is covered in the
appendix.
2. The weighted-average method is included
within the main portion of the chapter and it
is covered next.
B. The weighted-average method of calculating
equivalent units
Learning Objective 4-2: Compute the equivalent units
of production using the weighted-average method.
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i. Characteristics of the weighted-average method:
1. This method makes no distinction between
work done in the prior and current periods.
It blends together units and costs from the
prior and current periods.
2. The equivalent units of production for a
department are the number of units
transferred to the next department (or
finished goods) plus the equivalent units in
the department’s ending work in process
inventory.
ii. Treatment of direct labor
1. Direct labor costs are often small in
comparison to the other product costs in
process cost systems.
2. Therefore, direct labor and manufacturing
overhead are often combined into one
classification of product cost called
conversion costs. The forthcoming example
combines these costs.
iii. An example of the weighted-average method
1. Assume that Smith Company’s Assembly
Department reported activity for June as
shown on this slide.
2. The first step in calculating the equivalent
units is to identify the units completed and
transferred out of the department in June
(5,400 units for materials and
conversion).
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3. The second step is to identify the equivalent
units of production in ending work in
process with respect to materials for the
month (540 units) and adding this to the
5,400 units from step one.
4. The third step is to identify the equivalent
units of production in ending work in
process with respect to conversion for the
month (270 units) and adding this to the
5,400 units from step one.
Helpful Hint: Explain that there will most likely be
differences in the equivalent unit calculations between
materials and conversion costs, as materials are
usually added at the beginning of production, while
conversion costs are added during the period.
5. The equivalent units of production equals
the units completed and transferred out
(5,400 units) plus the equivalent units
remaining in work in process (540 units for
materials and 270 units for conversion).
6. A different visual depiction of the equivalent
units calculation for materials is shown on
this slide.
7. A different visual depiction of the equivalent
units calculation for conversion is shown on
this slide.
Helpful Hint: The treatment of beginning inventory
under the weighted-average method often puzzles
students, since work done in the prior periods is
included in the equivalent units. Explain that this is
called the weighted-average method precisely because
it averages together beginning inventory and work
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performed in the current period. Costs and units are
treated consistently. Both the equivalent units and the
costs that go into the unit cost calculations under the
weighted-average method include amounts already in
beginning inventory.
IV. Compute and apply costs
Learning Objective 4-3: Compute the cost per
equivalent unit using the weighted-average method.
A. Computing the cost per equivalent unit—weighted
average method
i. Assume the following additional facts with respect
to Smith Company’s Assembly Department.
ii. The formula for computing the cost per equivalent
units is as shown.
1. The numerators for Smith Company
($124,740 for materials and $85,050 for
conversion) are computed as shown.
2. The cost per equivalent unit for materials
($21.00) and conversion ($15.00) is
computed as shown.
a. The equivalent units of production
(5,940 for materials and 5,670 for
conversion) were computed on a
prior slide.
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Chapter 4 Process Costing
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B. Applying Costs—Weighted Average Method
Learning Objective 4-4: Assign costs to units using the
weighted-average method.
i. Computing the cost of ending work in process
inventory.
1. The first step is to record the equivalent
units of production in ending work in
process inventory (540 units for materials
and 270 units for conversion).
2. The second step is to record the cost per
equivalent unit ($21.00 for materials and
$15.00 for conversion).
3. The third step is to compute the cost of
ending work in process inventory ($11,340
for materials, $4,050 for conversion, and
$15,390 in total).
ii. Computing the cost of units transferred out.
1. The first step is to record the units
transferred out to the next department (5,400
units for materials and conversion).
2. The second step is to record the cost per
equivalent unit ($21.00 for materials and
$15.00 for conversion).
3. The third step is to compute the cost of units
transferred out ($113,400 for materials,
$81,000 for conversion and $194,400 in
total).
Learning Objective 4-5: Prepare a cost reconciliation
report.
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iii. Reconciling costs
1. Computing the costs to be accounted for:
a. The first step is to record the cost of
beginning work in process as shown
on slide 43 ($10,039).
b. The second step is to record the costs
added to production during the period
as shown on slide 43 ($199,751).
c. The third step is to sum these two
costs ($209,790).
2. Computing the costs accounted for:
a. The first step is to record the
previously computed cost of ending
working process inventory ($15,390).
b. The second step is to record the
previously computed cost of units
transferred out ($194,400).
c. The third step is to sum these two
costs ($209,790).
3. Notice the two totals agree indicating that all
costs have been accounted for.
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