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chapter
20
Process Cost Systems
______________________________________________
OPENING COMMENTS
Chapter 20 completes the coverage of manufacturing accounting by introducing process costing. The text
demonstrates process costing under the FIFO method. The average cost method is presented in the
chapter’s appendix. Chapter 20 also discusses the impact of just-in-time systems on manufacturing.
In this chapter, you need to consider which method(s) of process costing you will choose to cover in your
class. When the FIFO method is presented in the chapter (Objectives 2 and 3), the manufacturing
department adds materials at the beginning of production and conversion costs evenly throughout
production. This requires two sets of equivalent unit calculations. When the average cost method is
presented in the chapter appendix, the problems show materials and conversion costs both added evenly
throughout production, requiring only one equivalent unit calculation. This assumption, along with the
ability to commingle beginning work in process with units started and completed, greatly simplifies the
computations related to process costing.
The average cost method will still allow you to communicate the concept of equivalent units. If you want
to take a more conceptual approach, you could choose to only cover the average cost method and keep the
calculations more streamlined. If you want to dig into process costing more fully, the FIFO method may
be your choice. Carefully consider a decision to cover both methods. Coupling the two different methods
with two different sets of underlying assumptions may be very confusing, causing students to resort to
rote memorization rather than understanding the accounting procedures presented.
After studying the chapter, your students should be able to:
1. Describe process cost systems.
2. Prepare a cost of production report.
3. Journalize entries for transactions using a process cost system.
4. Describe and illustrate the use of cost of production reports for decision making.
372 Chapter 20 Process Cost Systems
5. Compare just-in-time processing with traditional manufacturing processing.
KEY TERMS
cost of production report
cost per equivalent unit
equivalent units of production
first-in, first-out (FIFO) method
just-in-time (JIT) processing
manufacturing cells
process cost system
process manufacturer
whole units
yield
STUDENT FAQS
• Why is it necessary to know the four steps of producing a cost of production report?
• What does equivalent units of production (EUP) mean, and why is it necessary for it to be correct?
• Started and completed under “units to be assigned cost” gives me problems every time. Do you have
a suggestion to eliminate my problem?
• Why does the complement of the percentage in beginning inventory have to be used to calculate EUP
when the percent of completed has to be used for the ending?
• Why is just-in-time (JIT) processing meant to cut out all waste of cost in manufacturing?
• Why do we do a material and conversion EUP only? Shouldn’t conversion be made into Direct Labor
and Factory Overhead to be more accurate?
OBJECTIVE 1
Describe process cost systems.
SYNOPSIS
A process manufacturer produces products that are homogeneous; they use a cost system called process
costing. This system records the costs of each department or process. Process costing is similar to job
costing in that each records and summarizes product costs, allocates overhead, uses perpetual inventory,
and provides useful information for decision making. The example in the chapter, using ice cream, adds
all materials at the beginning of the process. There are two departments: Mixing and Packaging. Labor
and overhead costs occur in each department. When the Mixing Department is done with the product, its
costs are transferred to the Packaging Department along with the product. When the Packaging
Department completes its process, the product costs are transferred to finished goods. The cost flows in
the process cost system are similar to the physical flow of goods. As shown in Exhibit 4, each department
Chapter 20 Process Cost Systems 373
has a separate overhead account. The overhead is applied to work in process by debiting each
department’s factory overhead account and crediting each department’s Work in Process. When the
product is transferred, Work in Process—Mixing Department is credited and Work in Process—
Packaging Department is debited. Lastly, the Packaging Department transfers the product to finished
goods. Finished Goods is debited for the amount transferred, and Work in Process—Packaging
Department is credited.
Key Terms and Definitions
• Process Cost System - A type of cost system that accumulates costs for each of the various
departments within a manufacturing facility.
• Process Manufacturer - A manufacturer that uses large machines to process a continuous flow
of raw materials through various stages of completion into a finished state.
Relevant Example Exercises and Exhibits
• Example Exercise 20-1 Job Order versus Process Costing
• Exhibit 1 – Examples of Process Cost and Job Order Companies
• Exhibit 2 – Process Cost and Job Order Cost Systems
• Exhibit 3 – Physical Flows for a Process Manufacturer
• Exhibit 4 – Cost Flows for a Process Manufacturer—Frozen Delight
SUGGESTED APPROACH
Transparency Masters (TMs) 20-1 through 20-3 explain the types of manufacturers that use job order and
process costing, as well as the similarities and differences in these two systems. Ask your students to give
examples of companies that would use job order costing and companies that would use process costing.
As an alternative, ask your students whether a soft drink bottler would use a process or job order system.
Because costs are accumulated by department in a process cost system, each department has its own work
in process account. Use TM 20-4 to explain the flow of costs through the departmental work in process
accounts. Exhibit 3 in the text presents another illustration to reinforce the cost flows for a process
manufacturer.
As you cover these illustrations, emphasize that there are separate work in process and factory overhead
accounts for each department. This allows the manufacturer to accumulate product costs by department.
Also stress that costs transferred out of one department become the costs transferred in to the next
department.
374 Chapter 20 Process Cost Systems
OBJECTIVE 2
Prepare a cost of production report.
SYNOPSIS
In a process system, the cost of units transferred out of each department must be determined along with
the cost of any partially completed units remaining in the department. These costs are reported in a cost
of production report. This report is prepared in four steps: (1) determine units to be assigned costs, (2)
compute equivalent units of production, (3) determine cost per equivalent unit, and (4) allocate costs to
units transferred out and partially completed units. In preparing the report, assumptions are made that the
FIFO inventory cost system is used. To complete Step 1, units to be included are determined by adding
the previous period’s ending inventory to the units received from materials inventory (or previous
process). These units are separated into groups based on how many units were started and how many units
are complete. Equivalent units of production are the portion of whole units that are complete with respect
to materials or conversion. The materials costs are 100% complete because all the materials are added at
the beginning. The conversion cost are 40% complete, and the equivalent units are all units in process
multiplied by 40%. The equivalent units are computed in Exhibit 7. Cost must be converted for both
materials and conversion costs. Cost per equivalent unit is computed as: total conversion costs for the
period/total equivalent units of conversion costs. Finally, product cost must be allocated to the units
transferred out and units partially complete. Cost is assigned to each group based on materials used and
percent of conversion complete. Exhibit 8 illustrates costs, equivalent units, and the computation of each
for the Mixing Department.
Key Terms and Definitions
• Cost of Production Report - A report prepared periodically by a processing department,
summarizing (1) the units for which the department is accountable and the disposition of those
units and (2) the costs incurred by the department and the allocation of those costs between
completed and incomplete production.
• Cost per Equivalent Unit - The rate used to allocate costs between completed and partially
completed production.
• Equivalent Units of Production - The number of production units that could have been
completed within a given accounting period, given the resources consumed.
• First-In, First-Out (FIFO) Method - The method of inventory costing based on the assumption
that the costs of merchandise sold should be charged against revenue in the order in which the
costs were incurred.
• Whole Units - The number of units in production during a period, whether completed or not.
Relevant Example Exercises and Exhibits
• Example Exercise 20-2 Units to Be Assigned Costs
• Example Exercise 20-3 Equivalent Units of Materials Cost
• Example Exercise 20-4 Equivalent Units of Conversion Costs
• Example Exercise 20-5 Cost per Equivalent Unit
• Example Exercise 20-6 Cost of Units Transferred Out and Ending Work in Process
• Exhibit 5 – July Units to Be Costed—Mixing Department
• Exhibit 6 – Direct Materials Equivalent Units
Chapter 20 Process Cost Systems 375
• Exhibit 7 – Conversion Equivalent Units
• Exhibit 8 – Cost of Production Report for Frozen Delight’s Mixing Department—FIFO
SUGGESTED APPROACH
TM 20-3 illustrates that each department in a process costing system can compute the cost to manufacture
one unit of product as follows:
Cost to Make One Unit in One Department = Department’s Cost for the Month
Number of Units Produced During the Month
The denominator of this equation assumes that whole units are completed during the month. However,
this usually is not the case. As a result, companies are forced to calculate equivalent units. Equivalent
units are the number of whole units that could have been made using the same manufacturing effort.
Explain the calculation of equivalent units and show how it is used in determining product costs.
GROUP LEARNING ACTIVITY—Cost of Production Report
Divide the class into small groups. Ask them to use the information and calculations from the
demonstration problem in TM 20-5 to prepare a cost of production report for Advanced Technologies’
assembly department. Refer your students to Exhibit 8 in the text as a model for this report. You may
want to review the major sections of the cost of production report prior to assigning this activity.
A completed cost of production report is shown on TMs 20-12 and 20-13.
LECTURE AID—Equivalent Units
The following scenario relates equivalent units to a common student dilemma.
Assume that you are taking four classes this term, and all four classes require a five-page paper. Of
course, when will these papers be due? (I’ve never had a class that didn’t immediately respond with the
following answer: the same day.) OK, if these papers are all due the same day, when will you start them?
(Once again, they always say: the night before they’re due.)
Assume that you write four pages on the first paper and run out of information. Then you write three
pages on the next paper and stop to watch a TV show. Next, you write two pages on the third paper before
you get too bored to continue. So you switch to the last paper and write one page before you fall asleep at
the keyboard. If you worked on one paper until it was finished and then started another paper, how many
papers would you have completed? (Answer: two papers—finished a total of ten pages)
Emphasize that there are two equivalent units in this example. Two finished papers could have been
written with the same effort used to do partial work on four papers.
376 Chapter 20 Process Cost Systems
DEMONSTRATION PROBLEM—Process Costing, FIFO Method
The text presents the calculation of product costs under FIFO process costing as a four-step process. Use
the following facts to demonstrate process costing (also on TM 20-5). This information refers to
Advanced Technologies, the three-department computer manufacturer described on TM 20-4.
Advanced Technologies produces notebook computers in three departments: assembly, testing, and
packing. Prior to the start of the production process, all the materials and component parts needed to
assemble a computer are placed into a “kit.” Manufacturing begins when the assembly department
receives a kit and begins putting the computer together. Therefore, all materials are added at the
beginning of work in the assembly department. Conversion costs are added evenly throughout the
assembly process.
Assume that the assembly department of Advanced Technologies began April with 800 units in its work
in process inventory. Assembly on these units was three-fourths complete at the beginning of the month.
During the month, 3,000 units were started in the assembly department. At the end of the month, 300 of
the units started were still in process; assembly on these units was two-thirds complete.
The costs associated with production in assembly during April were as follows:
Cost of units in beginning work in process inventory $228,000
Cost of materials used in April 630,000
Cost of direct labor and overhead for April 527,000
STEP 1: Determine the units to be assigned costs. Instruct students to begin by determining the total
number of units worked on in the assembly department during April plus the number of units in each of
the following three categories:
Beginning Work in Process Inventory
Units Started and Completed During the Month
Ending Work in Process Inventory
For example, Advanced Technologies worked on 3,800 units during April (the 800 in beginning work in
process plus the 3,000 units started this month.) There were 800 units in beginning work in process
inventory, 2,700 started and completed (3,000 started – 300 not completed) and 300 in ending work in
process inventory.
STEP 2: Calculate equivalent units of production. Since all materials are added by the assembly
department at the beginning of production, and conversion costs are added evenly throughout production,
equivalent units must be calculated separately for materials and conversion costs. Remind students that
conversion costs are the costs needed to “convert” raw materials to a finished product (labor and factory
overhead). The calculation of equivalent units can be summarized in the following equation:
Chapter 20 Process Cost Systems 377
No. of Whole Units Amount of Work Put into the Units during the Month
(expressed as a fraction or a percentage)
Material equivalent units for Advanced Technologies’ assembly department would be calculated as
follows:
% Materials
Whole Units Added in April Equivalent Units
Beginning WIP Inventory 800 0 0
Units Started and Completed 2,700 100% 2,700
Ending WIP Inventory 300 100% 300
3,000
Emphasize that all materials are added at the beginning of production. Therefore, no materials are added
to the beginning work in process inventory, which was placed into production last month.
Conversion equivalent units for Advanced Technologies’ assembly department would be calculated as
follows:
% Conversion
Whole Units Added in April Equivalent Units
Beginning WIP Inventory 800 1/4 200
Units Started and Completed 2,700 100% 2,700
Ending WIP Inventory 300 2/3 200
3,100
Emphasize that the percentage of completion can also be expressed as a fraction.
STEP 3: Determine the cost per equivalent unit. In order to determine the total cost to produce a unit, a
manufacturer must compute the materials cost and the conversion cost (labor and overhead) in a
completed unit. This amount is the cost per equivalent unit. The formula for this calculation is:
Costs Incurred During the Month
Cost per Equivalent Unit Equivalent Units Produced During the Month
=
For Advanced Technologies, cost per equivalent unit must be calculated separately for materials and
conversion costs since these resources are added at different rates in the manufacturing process (materials
are added all at the beginning and conversion costs evenly throughout the process).
Materials and conversion costs per equivalent unit are calculated as follows:
$630,000
Materials Cost/Equivalent Unit = $210
3,000 equiv. units
=
$527,000
Conversion Cost/Equivalent Unit $170
3,100 equiv. units
==
378 Chapter 20 Process Cost Systems
STEP 4: Allocate costs to transferred and partially completed units. After calculating the cost per
equivalent unit for materials and conversion costs, the cost of units completed and those still in process
must be determined. Stress that students will have the most success if they calculate the cost separately
for each category of units on the equivalent units’ schedule. The beginning work in process and started
and completed categories represent units that have been completed in assembly and transferred on to the
testing department. The ending work in process represents the units that have not been completed.
The cost assigned to the units that were in beginning work in process is:
Direct Materials Conversion Cost Total Cost
Beginning WIP Balance $228,000
Cost to Complete:
Equivalent Units for April 0 200
Cost per Equivalent Unit $210 $170
0 34,000 34,000
Cost of April 1 WIP
transferred to testing $262,000
The cost assigned to the units that were started and completed in April is:
Direct Materials Conversion Cost Total Cost
Started and Completed:
Equivalent Units 2,700 2,700
Cost per Equivalent Unit $210 $170
Cost of Units Started & $567,000 $459,000 $1,026,000
Completed in April
Remind students that the total cost of units completed and transferred to testing is $1,288,000 ($262,000 +
$1,026,000). This amount must be transferred from the work in process account for the assembly
department to the testing department’s work in process account. Note that the journal entry is covered in
Objective 3.
WIP Inventory—Testing Department 1,288,000
WIP Inventory—Assembly Department 1,288,000
The cost assigned to the units that were in ending work in process inventory on April 30 is:
Direct Materials Conversion Cost Total Cost
Ending WIP Inventory:
Equivalent Units 300 200
Cost per Equivalent Unit $210 $170
Total Cost of Ending WIP $63,000 $34,000 $97,000
Chapter 20 Process Cost Systems 379
CLASS DISCUSSION—Process Costing
In the previous Demonstration Problem, all materials were introduced at the beginning of the production
process. Ask your students for other examples of materials that would be added at the start of production.
Additional ideas include soup broth for soup making, alumina for aluminum smelting, crude oil for
gasoline refining, or pulp for papermaking. Next ask your students for materials that would not be added
at the beginning of the manufacturing process. Examples include icing for cake baking, varnish for
making wood furniture, or packing material for any product delivered in a box.
In the Advanced Technologies problem, all conversion costs were incurred evenly throughout the
production process. Ask your students for an example of an overhead cost that would not be incurred
evenly. One example would be energy costs. Frequently, the energy component is not used at exactly the
same rate throughout processing. Therefore, some companies separate the energy cost from conversion
costs and account for it separately.
GROUP LEARNING ACTIVITY—Process Costing with Transferred in Costs,
FIFO Method
The textbook illustrates process costing for the first department in a manufacturing process. End of
chapter problems also ask students to calculate product costs for departments that are second or third in
the manufacturing flow. Emphasize that all departments that receive units from prior departments also
receive costs that are “transferred in” from those departments. Transferred in costs can be treated in the
same manner as materials added at the beginning of the production process.
TM 20-6 presents information to calculate and assign costs to units in Advanced Technology’s testing
department for the month of April. The four-step solution to this problem is provided on TMs 20-7
through 20-11. Allow your students the opportunity to practice FIFO process costing by working in
groups. Since most students struggle with this topic, the time for group work is well spent.
OBJECTIVE 3
Journalize entries for transactions using a process cost system.
SYNOPSIS
Next, journal transactions are discussed as these product transfers need to be journalized. Materials are
purchased and the materials account is debited and Accounts Payable is credited. As the direct materials
are requisitioned, work in process accounts are debited and Materials is credited. When indirect materials
are requisitioned or other indirect expenses are recognized, factory overhead accounts are debited and
either Materials or other accounts are credited. Applied factory overhead is then charged to the
departments by debiting the department’s work in process account and crediting the same department’s
factory overhead account. When products are transferred from department to department, the receiving
department’s work in process account is debited and the transferring department’s work in process
account is credited. When the units are entirely complete, Finished Goods is debited and Work in
380 Chapter 20 Process Cost Systems
Process—Packaging is credited. After the product is sold, Cost of Goods Sold is debited and Finished
Goods is credited. These cost flows are shown in Exhibit 9.
Relevant Example Exercises and Exhibits
• Example Exercise 20-7 Process Cost Journal Entries
• Exhibit 9 – Frozen Delight’s Cost Flows
SUGGESTED APPROACH
A process cost system requires only a few modifications to the journal entries illustrated for a job order
manufacturer in Chapter 19. These modifications are as follows:
1. Separate work in process accounts are maintained for each department.
2. Separate factory overhead accounts are maintained for each department.
3. To determine the cost of units transferred from one production department to the next department (or
to finished goods), equivalent units must be computed and costs assigned using the method illustrated
under Objective 2.
Refer students to the journal entries illustrated in the text. Stress that a cost of production report or four-
step process costing calculation must be prepared to determine the cost of units transferred to the various
departments and the cost of completed units transferred to finished goods.
It would be an excellent learning activity to ask your students to work in groups to complete a process
costing problem and all related journal entries at this point. However, that activity would be extremely
lengthy. As an alternative, give your students the opportunity to start a homework assignment requiring
journal entries (such as Problem 20-1A or 20-1B) in class. This will allow them to ask any questions
necessary to get started on the “right foot.”
OBJECTIVE 4
Describe and illustrate the use of cost of production reports for decision making.
SYNOPSIS
Using the cost of production reports, managers can track and analyze these costs over time. By
investigating the causes of increases or problems, managers can make decisions regarding efficiency and
improvement. In addition, managers are concerned about yield, computed as: yield = quantity of material
output/quantity of material input.
Key Terms and Definitions
• Yield - A measure of materials usage efficiency.
Chapter 20 Process Cost Systems 381
Relevant Example Exercises and Exhibits
• Example Exercise 20-8 Using Process Costs for Decision Making
SUGGESTED APPROACH
The objective in this section is to move the students from preparing cost reports to using them for
decision making. A manufacturing cost system provides the user with a database of cost information. This
database can be used to segment cost data in a number of ways, such as by product, by process, by
production line, or by work shift. This detail gives manufacturers the ability to discover the root causes of
cost problems. Use the Group Learning Activity below to develop these issues in class.
You may also want to point out that the cost of production report illustrated in the text is highly
summarized. In a real-world setting, each significant material and energy input would be individually
identified. In most cases, conversion costs are not lumped together but would be individually identified as
well.
GROUP LEARNING ACTIVITY—Decision Making Exercise
Provide students with Handout 20-1. This handout describes a situation where material costs have been
stratified by line and by shift. This information will give students an opportunity to think in relational
database terms. There are often a number of different ways to view data. Asking for the right view and
then interpreting the patterns that you see is part of the role of a business analyst. The solution to Handout
20-1 is provided in TM 20-14.
OBJECTIVE 5
Compare just-in-time processing with traditional manufacturing processing.
SYNOPSIS
The objective of most manufacturers is to produce goods with high quality, low cost, and instant
availability. Just-in-time processing is an approach that focuses on reducing time and cost and eliminating
poor quality. The traditional manufacturing process is streamlined, waiting time is eliminated, workers
become multifunctional, and inventories are reduced when using JIT methods.
Key Terms and Definitions
• Just-in-Time (JIT) Processing - A processing approach that focuses on eliminating time, cost,
and poor quality within manufacturing and nonmanufacturing processes.
• Manufacturing Cells - A grouping of processes where employees are cross-trained to perform
more than one function.
382 Chapter 20 Process Cost Systems
Relevant Example Exercises and Exhibits
• Exhibit 10 – Traditional Production Line
• Exhibit 11 – Just-in-Time Production Line
SUGGESTED APPROACH
Just-in-time (JIT) manufacturing is not just a method of reducing inventory. It is embraced as a
philosophy that emphasizes eliminating waste from all processes. Inventory is simply a buffer that
protects a process against unreliability (such as poor supplier delivery or machinery that breaks down
frequently). Reducing inventory levels without correcting the problems that create unreliability will stop
production. Constructing a reliable system will eliminate the need for an inventory buffer.
Exhibits 9 and 10 in the text illustrate the production line and flow of products under a traditional and a
JIT system. Review these diagrams with your students and emphasize the following points.
1. JIT organizes work cells that perform several manufacturing steps. Workers are cross-trained to
perform more than one task. This allows manufacturing to be more flexible and gives workers more
pride in the final product.
2. Because products do not move between as many departments, the non-value-added cost of
transporting products and parts is reduced.
Emphasize that the employee involvement in a JIT system also implies employee accountability.
Employees cannot be either involved or accountable without information. If employees are to be
accountable for financial performance, then they will need access to financial information. Therefore,
financial information cannot be limited to managers in a JIT organization. All employees must have
access and be trained to interpret financial data.
IN-CLASS SIMULATION—Just-in-Time Manufacturing
Just-in-time is essentially a demand-pull system. Products are not made until they are needed by the
customer, and component parts are not made until they are needed by the next stage of production. Just-
in-time significantly reduces inventories, allowing manufacturers to reduce costs incurred in moving and
storing inventory. Just-in-time also emphasizes quality.
You can simulate the difference between the traditional push system and the demand-pull system of just-
in-time in your classroom. You will need scrap paper, four pens, a stapler, and six volunteers. Divide the
scrap paper between two volunteers. Instruct one student to write an “A” on his or her pieces of paper,
and ask the other to write a “B.” Use another volunteer as an expediter to collect the completed A and B
papers and carry them to a fourth volunteer, who staples the papers together. The fifth volunteer picks up
the stapled sets of paper and delivers them to the sixth volunteer—the customer.
As a first simulation, instruct all volunteers to do their assigned tasks as quickly as possible. Tell them to
focus on quantity and ignore quality. Allow them to work for 30 seconds, then stop the production line.
Announce that the customer wants to change the color of the ink used to write the As and Bs, effective
Chapter 20 Process Cost Systems 383
immediately. Therefore, any work in process will need to be scrapped. Count the scrapped sheets. Allow
your students to work for another 30 seconds. Ask your customer to count the completed products he or
she received.
Run this simulation a second time, but this time institute a demand-pull system. Instruct all workers that
they are not to make a new product (or component) until it is needed for the next stage of production.
Also ask them to focus on quality, not quantity. In addition, physically move the students who are writing
letters close enough to the student stapling the papers so that an expediter is not needed to move the
papers from one station to the next. Allow your students to work for 30 seconds. After that time, stop
production, announce another ink color change, and collect any work in process as scrap. Start up the
production line again for another 30 seconds. Ask your customer to count the completed products
received.
You should find that the number of completed units is about the same under either system. However, the
amount of scrap will be dramatically reduced under the just-in-time system. In addition, you may want to
ask your customer to compare the quality of the output. It should be significantly higher under the second
simulation.
LECTURE AID—Value-Added versus Non-Value-Added
Each activity performed by an organization creates cost. If the activity does not create any value for the
customer, its cost represents wasted resources and it can be labeled as “non-value-added.” Since one of
the goals of a JIT system is to eliminate waste, non-value-added activities should be identified and
eliminated, if possible.
The following questions can aid students in determining if an activity is value-added or non-value-added.
1. Given a choice, would the customer pay for this activity?
2. If you quit performing this activity, would the customer care?
3. If you quit performing this activity, would the output still meet customer requirements?
4. Could you eliminate this activity if some other activity were done correctly or differently?
5. Would reengineering the system eliminate this activity?
A “yes” answer to questions 1 or 2 indicates a value-added activity. A “yes” answer to questions 3, 4, or 5
indicates a non-value-added activity.
384 Chapter 20 Process Cost Systems
APPENDIX—AVERAGE COST METHOD
SYNOPSIS
The appendix illustrates how the average cost method affects the cost of production report. It is completed
in four steps: (1) determine units to be assigned costs, (2) compute equivalent units of production, (3)
determine cost per equivalent unit, and (4) allocate costs to transferred out and partially complete units.
Compare Exhibits 8 and 12 to see how the average cost method changes to amounts allocated to
equivalent units.
Relevant Example Exercises and Exhibits
• Exhibit 12 – Cost of Production Report for S&W’s Mixing Department—Average Cost
SUGGESTED APPROACH
If you are going to present only the average cost method of process costing, you will want to start by
thoroughly explaining the need for equivalent units. Begin by using TM 20-3 to illustrate that each
department in a process costing system can compute the cost to manufacture one unit of product as
follows:
Department's Cost for the Month
Cost to Make One Unit in One Department Number of Units Produced During the Month
=
The denominator of this equation assumes that whole units are completed during the month. However,
this usually is not the case. As a result, companies are forced to calculate equivalent units. Equivalent
units are the number of whole units that could have been made using the same manufacturing effort. Refer
to the section entitled “LECTURE AIDS — Equivalent Units” under Objective 3 for material to help you
explain the concept of equivalent units. Then, use the following demonstration problem to present the
four steps to solve an average cost process costing problem.
DEMONSTRATION PROBLEM—Process Costing, Average Cost Method
Use the following facts to demonstrate process costing (also on TM 20-15).
Healthy Harvest Company is a bakery that makes breads. The manufacturing department is organized into
three departments: dough making, baking, and packaging. The following information is related to the
dough making department:
Cost data for the month of April:
Work in process inventory, April 1 (100 units, 40 percent complete) $ 49.00
Direct materials cost (for 2,050 units) 400.00
Direct labor cost 80.00
Factory overhead applied 220.00
Total production costs $749.00
Chapter 20 Process Cost Systems 385
Unit data:
Units transferred to baking in April 2,100
Units in work in process on April 30 (80 percent complete) 50
STEP 1: Determine the units to be assigned costs. In this step, students determine the total number of
units worked on in the dough-making department during April from both an “Input” and an “Output”
perspective.
The Input Perspective:
Units in work in process, April 1 100
Units started in production, based on materials requisitioned 2,050
Total units to be accounting for 2,150
The Output Perspective:
Units transferred out to the next department (baking) 2,100
Units in work in process, April 30 50
Total units to be accounting for 2,150
In reality, the preceding calculations only use the numbers identified under the “Output” perspective.
STEP 2: Calculate equivalent units of production. In the textbook problems and exercises based on the
chapter appendix, students must assume that materials and conversion costs are added evenly throughout
production. Therefore, only one equivalent unit calculation is required. If you have not covered the FIFO
method, students won’t be expecting two equivalent unit calculations (one for materials and one for
conversion costs), so you won’t even need to mention this assumption.
In the average cost method, the calculation of equivalent units can be summarized in the following
equation:
No. of Whole Units Percent of these units complete at the end of the month
(expressed as a fraction or a percentage)
Equivalent units for Healthy Harvests’ dough-making department would be calculated as follows:
Equivalent units transferred to baking in April (2,100 100%) 2,100
Equivalent units in work in process on April 30 (50 80%) 40
Total equivalent units 2,140
Emphasize that the equivalent units for the ending work in process is 40 because doing 80 percent of the
work on 50 units takes the same resources as doing 100 percent of the work on 40 units.
386 Chapter 20 Process Cost Systems
STEP 3: Determine the cost per equivalent unit. The formula for this calculation is:
Total Production Costs
Cost per Equivalent Unit Total Equivalent Units
=
Continuing with the data for Healthy Harvest, the cost per equivalent unit is:
$749
Cost/Equivalent Unit $0.35
2,140 equiv. units
==
STEP 4: Allocate costs to transferred and partially completed units. In this step, students calculate the
cost that is transferred to the baking department and the costs that remain in the dough-making
department’s work in process account. For each of those categories, the costs are determined as follows:
# of equivalent units cost per equivalent unit
Using the data from Healthy Harvest:
Costs transferred to the baking department
(2,100 equivalent units $0.35) $735
Costs of dough making’s WIP on April 30
(40 equivalent units $0.35) 14
Total production costs assigned $749
From a journal entry perspective, $735 is transferred from WIP-dough making to WIP-baking. The
balance remaining in WIP-dough making after this entry is posted would be $14.
GROUP LEARNING ACTIVITY—Process Costing Using the Average Cost
Method
TM 20-16 presents data for Healthy Harvest’s baking department for the month of April. Ask your
students to perform the four-step process costing calculations using the average cost method. The solution
is on TMs 20-17 and 20-18.
Next, ask students to prepare a cost of production report using text Exhibit 11 as a model. The cost of
production report simply shows the calculations on TMs 20-17 and 20-18 in a different format. Use the
numbers on these TMs to check your students’ work.
Handout 20-1
Decision Making Using Process Cost Data
Hall Company produces synthetic materials from a chemical extrusion processes. Management
has been concerned that material costs per pound are too high. Hall produces only a single
product on four separate extrusion lines. The product is processed over two shifts per day. The
following data have been collected for analysis:
January
Total materials costs .......................................................................... $335,050
Total number of pounds produced...................................................... 50,400
Cost per pound .................................................................................. $6.65
Materials Costs by Production Line
Line 1 Line 2 Line 3 Line 4 Total
Shift 1 ................................. $36,000 $36,000 $40,300 $36,000 $148,300
Shift 2 ................................. 45,500 45,500 50,250 45,500 186,750
Total .................................... $81,500 $81,500 $90,550 $81,500 $335,050
Pounds Produced by Production Line
Line 1 Line 2 Line 3 Line 4 Total
Shift 1 ................................. 6,000 6,000 6,200 6,000 24,200
Shift 2 ................................. 6,500 6,500 6,700 6,500 26,200
Total .................................... 12,500 12,500 12,900 12,500 50,400
Assume you have interviewed the following individuals in an attempt to discover the problems
causing material costs to be inflated: Juanita Marcos, shift 1 supervisor; Ed Curcek, shift 2
supervisor; and Hal Bundy, plant manager. A summary of their responses are given below.
Hal: I just received a directive from headquarters to increase my production rates. I talked to Ed
and Juanita about kicking up our production from our old average of 6,000 pounds per shift.
Juanita did not seem to think that this was a good idea. My bet is that our problems are with
Juanita’s shift.
Juanita: I have decided to keep first-shift production on lines 1, 2, and 4 at 6,000 pounds per
shift. That’s because I remember the last time we had our production rates increased. Our
materials consumption shot through the roof. Therefore, I’m running a small experiment on Line
3 before increasing the speeds across the whole shift. I know Ed has increased production on
the second shift, but he was just brought in from another plant that has new machinery. I don’t
expect he’s had the historical experience with these older machines that I’ve had.
Ed: I’ve increased production rates on my shift, but it’s hard to tell how things are going. I
thought the new directive made plenty of sense. Back at my previous plant location, we ran
machines at 7,000 pounds per shift without any trouble. These older machines don’t seem to be
running nearly as well as the machines back at my old place. I guess when we see the numbers
at the end of the month we’ll have a good feel for it.
Required: Provide an analysis of the data that will assist the management of Hall Company
determine whether or not the increase in production rates is having a favorable impact on
production costs.
Type Item Description LO(s) Difficulty Time Est BUSPROG AICPA ACBSP - APC Bloom's EE Excel GL SMH FAI Service Real World Writing Ethics Internet Group
DQ 1 1 Easy 5 min. Analytics Measurement Process Costing Remembering
DQ 2 1 Easy 5 min. Analytics Measurement Process Costing Remembering
DQ 3 1 Easy 5 min. Analytics Measurement Process Costing Remembering
DQ 4 2 Easy 5 min. Analytics Measurement Process Costing Remembering
DQ 5 2 Easy 5 min. Analytics Measurement Process Costing Remembering
DQ 6 3 Easy 5 min. Analytics Measurement Process Costing Remembering
DQ 7 4 Easy 5 min. Analytics Measurement Process Costing Remembering
DQ 8 4 Easy 5 min. Analytics Measurement Process Costing Remembering
DQ 9 4 Easy 5 min. Analytics Measurement Process Costing Remembering
DQ 10 5 Easy 5 min. Analytics Measurement Process Costing Remembering
PE 1A Job order vs. process costing 1 Easy 5 min. Analytics Measurement Process Costing Remembering x
PE 1B Job order vs. process costing 1 Easy 5 min. Analytics Measurement Process Costing Remembering x
PE 2A Units to be assigned costs 2 Easy 5 min. Analytics Measurement Process Costing Applying x
PE 2B Units to be assigned costs 2 Easy 5 min. Analytics Measurement Process Costing Applying x
PE 8B Using process costs for decision making 4 Easy 5 min. Analytics Measurement Process Costing Applying x
EX 1 Entries for materials cost flows in a process cost system 1,3 Easy 5 min. Analytics Measurement Process Costing Remembering
EX 2 Flowchart of accounts related to service and processing departments 1 Easy 5 min. Analytics Measurement Process Costing Remembering
EX 3 Entries for flow of factory costs for process cost system 1,3 Easy 10 min. Analytics Measurement Process Costing Applying x
EX 4 Factory overhead rate, entry for applying factory overhead, and factory overhead account balance 1,3 Easy 10 min. Analytics Measurement Process Costing Applying x
EX 5 Equivalent units of production 2 Easy 5 min. Analytics Measurement Process Costing Applying x
EX 6 Equivalent units of production 2 Moderate 15 min. Analytics Measurement Process Costing Applying x
EX 7 Equivalent units of production 2 Moderate 15 min. Analytics Measurement Process Costing Applying x
EX 8 Cost per equivalent unit 2,4 Moderate 30 min. Analytics Measurement Process Costing Applying x
EX 9 Equivalent units of production 2 Moderate 10 min. Analytics Measurement Process Costing Applying
EX 10 Cost per equivalent unit 2 Moderate 15 min. Analytics Measurement Process Costing Applying x
EX 11 Equivalent units of production and related costs 2 Moderate 15 min. Analytics Measurement Process Costing Applying x x
EX 12 Costs of units completed and in process 2,4 Moderate 30 min. Analytics Measurement Process Costing Applying x
EX 13 Errors in equivalent unit coputation 2 Moderate 20 min. Analytics Measurement Process Costing Applying
EX 14 Cost per equivalent unit 2 Moderate 15 min. Analytics Measurement Process Costing Applying x
EX 15 Costs per equivalent unit and production costs 2,4 Moderate 30 min. Analytics Measurement Process Costing Applying
EX 16 Cost of production report 2,4 Moderate 20 min. Analytics Measurement Process Costing Applying x
EX 17 Cost of production report 2,4 Moderate 20 min. Analytics Measurement Process Costing Applying
EX 18 Cost of production and journal entries 1,2,3,4 Moderate 30 min. Analytics Measurement Process Costing Applying
EX 30 Cost per equivalent unit: average cost method Appendix Moderate 20 min. Analytics Measurement Process Costing Applying x
PR 1A Entries for process cost system 1,3 Moderate 1.5 hours Analytics Measurement Process Costing Applying x x
PR 2A Cost of production report 2,4 Moderate 1.5 hours Analytics Measurement Process Costing Applying x
PR 3A Equivalent units and related costs: cost of production report 2,3,4 Challenging 1.5 hours Analytics Measurement Process Costing Applying x x
PR 4A Work in process account data for two months: cost of production reports 1,2,3 Moderate 2 hours Analytics Measurement Process Costing Applying x x
PR 5A Equivalent units and related costs: cost of production report: average cost method Appendix Moderate 1 hours Analytics Measurement Process Costing Applying x
PR 1B Entries for process cost system 1,3 Moderate 1.5 hours Analytics Measurement Process Costing Applying x x
PR 2B Cost of production report 2,4 Moderate 1.5 hours Analytics Measurement Process Costing Applying x
PR 3B Equivalent units and related costs: cost of production report 2,3,4 Challenging 1.5 hours Analytics Measurement Process Costing Applying x x
PR 4B Work in process account data for two months: cost of production reports 1,2,3 Moderate 2 hours Analytics Measurement Process Costing Applying x x
PR 5B Equivalent units and related costs: cost of production report: average cost method Appendix Moderate 1 hours Analytics Measurement Process Costing Applying x
CP 1 Ethics and professional conduct in business 1 Easy 10 min. Ethics Measurement Process Costing Analyzing x
CP 2 Accounting for materials cost 2 Moderate 15 min. Analytics Measurement Process Costing Analyzing x
CP 3 Analyzing unit costs 4 Moderate 15 min. Analytics Measurement Process Costing Analyzing x
CP 4 Decision making 4 Challenging 30 min. Analytics Measurement Process Costing Analyzing
CP 5 Process costing companies 1 Moderate 45 min. Analytics Measurement Process Costing Applying
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