8–1
Chapter 8
Process Costing
Learning Objectives
1. Explain the concept and purpose of equivalent units.
2. Assign costs to products using a five-step process.
3. Assign costs to products using weighted-average costing.
4. Prepare and analyze a production cost report.
5. Assign costs to products using first-in, first-out (FIFO) costing.
6. Analyze the accounting choice between FIFO and weighted-average costing.
7. Know when to use process or job costing.
8. Compare and contrast operation costing with job costing and process costing.
Chapter Overview
I. DETERMINING EQUIVALENT UNITS
II. USING PRODUCT COSTING IN A PROCESS INDUSTRY
• Step 1: Measure the Physical Flow of Resources
• Step 2: Compute the Equivalent Units of Production
• Step 3: Identify the Product Costs for Which to Account
III. REPORTING THIS INFORMATION TO MANAGERS: THE PRODUCTION COST
REPORT
• Sections 1 and 2: Managing the Physical Flow of Units
• Sections 3, 4, and 5: Managing Costs
IV. ASSIGNING COSTS USING FIRST-IN, FIRST-OUT (FIFO) PROCESS COSTING
• Step 1: Measure the Physical Flow of Resources
• Step 2: Compute the Equivalent Units of Production
• Step 3: Identify the Product Costs for Which to Account
• Step 4: Compute the Costs per Equivalent Unit: FIFO
• Step 5: Assign Product Cost: FIFO
• How this Looks in T-Accounts
V. DETERMINING WHICH IS BETTER: FIFO OR WEIGHTED AVERAGE?
VI. COMPUTING PRODUCT COSTS: SUMMARY OF THE STEPS
VII. USING COSTS TRANSFERRED IN FROM PRIOR DEPARTMENTS
• Who Is Responsible for Costs Transferred in From Prior Departments?
VIII. CHOOSING BETWEEN JOB AND PROCESS COSTING
IX. OPERATION COSTING
• Product Costing in Operations
• Operation Costing Illustration
X. COMPARING JOB, PROCESS, AND OPERATION COSTING
8–3
Chapter Outline
LO 8-1 Explain the concept and purpose of equivalent units.
• In job costing, each job is considered unique and can (but might not) follow the same path
through the production as other jobs. Processing costing assumes that all units are
homogeneous and follow the same path through the production processes.
DETERMINING EQUIVALENT UNITS
• Equivalent units (EU) represent the number of complete physical units to which units in
inventories are equal in terms of work done to date.
o Equivalent units = Number of physical units × Estimated (average) percentage of
completion with respect to the individual resource.
o Exhibit 8.2 illustrates the equivalent unit concept.
8–4
LO 8-2 Assign costs to products using a five-step process.
USING PRODUCT COSTING IN A PROCESS INDUSTRY
• Five-step process of assigning costs to products:
o Measure the physical flow of resources.
o Compute the equivalent units of production.
o Identify the product costs for which to account.
o Compute the costs per equivalent unit.
o Assign product cost to batches of work.
o The physical flow of resources in the Compounding Department of Torrance Tape, Inc.
(2T) for the month of March, Year 2 is provided in Exhibit 8.3.
• Step 1: Measure the Physical Flow of Resources
o The inventory equation (see Chapter 6) can be adapted to ensure that the work done has
been properly accounted for. That is,
Beginning work-in–
process inventory
+
Unit
started
=
Units
transferred out
+
Ending work-in–
process inventory
▪ Another way to look at the inventory equation is via the following statement format:
▪ A third way to study the inventory equation is through the T-account:
Work-in-Process Inventory
Beginning balance
Plus: Units started
Less: Units transferred out
Ending balance
o The production process for 2T is shown in Exhibit 8.4.
Beginning work-in-process inventory
xxx
Plus: Units started
xxx
Total units to account for
xxx
Units transferred out
xxx
Plus: Ending work-in-process inventory
xxx
Total units accounted for
xxx
8–5
• Step 2: Compute the Equivalent Units of Production
o In cases where materials are added at the beginning of the production process, while
labor and overhead (conversion resources) are added continuously throughout the process,
the calculation of equivalent units has to be done separately for each resource (materials
and conversion) introduced during the process.
o The computation of equivalent units in 2T’s Compounding Department is shown in
Exhibit 8.4. (See Business Application box “Overstating Equivalent Units to Commit
Fraud.”)
▪ Materials
• Because all materials are added at the beginning of the production process, the
equivalents units are calculated as follows:
▪ Conversion
• Because labor and overhead (conversion resources) are added continuously
throughout the process, the equivalents units are calculated as follows::
Equivalent units = Number of units transferred out + (Units in work in process at
the end of the month x Percent compete with respect to conversion)
• Step 3: Identify the Product Costs for Which to Account
o The costs collected include not only those incurred for production but also those in the
beginning work-in-process inventory. The work that has been done comes from two
sources:
• Time Out! We Need to Make an Assumption About Costs and the Work-In-Process
Inventory
o There are two approaches available for product costing purposes.
▪ Weighted-average process costing is an inventory method that combines costs and
equivalent units of a period with the costs and the equivalent units in beginning
inventory from the last period.
▪ First-in, first-out (FIFO) process costing is an inventory method whereby the first
goods received are the first ones charged out when sold or transferred.
• The FIFO method separates the costs of the current work and the work in the
beginning work-in-process inventory, assuming that all beginning work-in–
process units are transferred out first.
LO 8-3 Assign costs to products using weighted-average costing.
• Step 4: Compute the Costs per Equivalent Unit: Weighted Average
o Exhibit 8.8 illustrates the calculation of the equivalent unit cost for materials and for
conversion using the weighted-average method.
• Step 5: Assign Product Cost to Batches of Work: Weighted-Average Process Costing
o Once the costs per equivalent unit are computed, the final step is to assign the total costs
to the two batches of work: the units transferred out and the units not complete.
▪ The total costs to account for must equal the total costs accounted for.
Costs in Beginning work in process inventory
$xxx
Plus: Current period costs
xxx
Total costs to account for
$xxx
Costs assigned to units transferred out
$xxx
Plus: Costs assigned to ending work in process inventory
xxx
Total costs accounted for
$xxx
Beginning balance
Plus: Current period costs
Less: Cost of units transferred out
Ending balance
o Recording the Cost Flows in T-Accounts
▪ Exhibit 8.10 shows the flow of costs through the T-accounts. A general format for the
work-in-process inventory account follows.
See Demonstration Problem 1
8–8
LO 8-4 Prepare and analyze a production cost report.
REPORTING THIS INFORMATION TO MANAGERS: THE PRODUCTION COST
REPORT
• A production cost report summarizes production and cost results for a period and is
generally used by managers to monitor production and cost flows.
o As illustrated in Exhibit 8.11, the report is presented in five sections, each of which
corresponds to a step for assigning costs to goods transferred out and to ending work–in–
process inventory.
▪ Section 1 summarizes the flow of physical units.
▪ Section 2 shows the equivalent unit calculation.
• Sections 1 and 2: Managing the Physical Flow of Units
o Sections 1 and 2 of the production cost report correspond to steps 1 and 2 of the cost flow
model.
LO 8-5 Assign costs to products using first-in, first-out (FIFO) costing.
ASSIGNING COSTS USING FIRST-IN, FIRST-OUT (FIFO) PROCESS COSTING
• A disadvantage of the weighted-average method is that it mixes current period costs with the
costs of products from the last period in the beginning inventory, making it impossible for
managers to know how much it cost to make a product this period.
8–9
o The FIFO method separates current period costs from those in the beginning inventory.
o The FIFO method gives managers better information about the work done in the current
period.
• If the production process is a FIFO process, the inventory numbers are more likely to reflect
reality under FIFO costing than under weighted-average costing because the units in ending
work-in-process inventory are likely to have been produced in the current period.
o Computing product costs using a FIFO process costing system requires the same five-step
procedure as the weighted-average approach.
▪ Step 1: Measure the physical flow of resources.
• Step 1: Measure the Physical Flow of Resources
o The choice of accounting for production costs does not change the physical flow of
production. But the number of units completed and transferred out can be separated into
two groups: those that came from the beginning work-in-process inventory and those that
• Step 2: Compute the Equivalent Units of Production
o The FIFO equivalent unit computation is confined only to what was produced this period.
Under FIFO, equivalent units are computed in three parts for each distinct resource:
8–10
• Example 2: There are 200 units in the beginning work-in-process inventory, 40
percent complete with respect to materials, labor, and overhead. In the current
period, additional 4,800 units are started. After transferring out 4,500 completed
units, the factory is left with 500 units in the ending work-in-process inventory,
25 percent complete with respect to materials, labor, and overhead.
If the FIFO method is adopted, it can be determined that 4,300 units (= 4,500
units – 200 units) are started and completed during the current period.
The equivalent units can be calculated as follows:
Physical
Units
Equivalent units
Materials, Labor, Overhead
To complete beginning inventory
200
120
o The equivalent units under FIFO are less than or equal to those under the weighted-
average method because the FIFO computations refer to the current period’s production
only; weighted-average equivalent units consider all units in the department, whether
produced this period or in the previous period.
• Step 3: Identify the Product Costs for Which to Account
• Step 4: Compute the Costs per Equivalent Unit: FIFO
o Under FIFO, the costs per equivalent unit are confined to the costs incurred this period
and the equivalent units produced this period. That is,
Units started and completed (100%)
Work in ending inventory (25%)
500
125
8–11
See Demonstration Problem 2
LO 8-6 Analyze the accounting choice between FIFO and weighted-average
costing.
DETERMINING WHICH IS BETTER: FIFO OR WEIGHTED AVERAGE?
• Weighted-average costing does not separate beginning inventory from current period activity.
Unit costs are a weighted average of the two, whereas FIFO costing bases unit costs on
current period activity only.
• Exhibit 8.14 compares the unit costs, costs transferred out, and ending work–in-process
inventory values under the two methods for 2T’s Compounding Department.
o Although either weighted-average or FIFO costing is acceptable for assigning costs to
inventories and cost of goods sold for external reporting, the weighted-average method
has been criticized for masking current period costs.
COMPUTING PRODUCT COSTS: SUMMARY OF THE STEPS
• Exhibit 8.15 provides a summary of the steps for assigning costs to units of production using
process costing and assuming either a weighted-average or FIFO cost flow.
USING COSTS TRANSFERRED IN FROM PRIOR DEPARTMENTS
• As the product passes from one department to another, its costs must follow.
See Demonstration Problem 3
• Who Is Responsible for Costs Transferred in From Prior Departments?
o An important question for performance evaluation is whether a department manager
should be held accountable for all costs charged to the department. The answer is usually
no.
8–13
LO 8-7 Know when to use process or job costing.
CHOOSING BETWEEN JOB AND PROCESS COSTING
• In job costing, costs are collected for each unit produced. Process costing accumulates costs
in a department for an accounting period and then spreads them evenly, or on an average
basis, over all units produced during the period.
• The choice of process versus job costing systems involves a comparison of the costs and
benefits of each system. The production process being utilized is also a major factor in
choosing a cost system.
LO 8-8 Compare and contrast operation costing with job costing and
process costing.
OPERATION COSTING
• Exhibit 8.17 shows a comparison of the three product costing methods.
• Operation costing is a hybrid of job and process costing that is used in manufacturing goods
that have some common characteristics and some individual characteristics.
o An operation is a standardized method of making a product that is repeatedly performed.
8–14
• Product Costing in Operations
o The key difference between operation costing and the two methods discussed in this
chapter and the previous chapter, job and process costing, is that for each work order or
batch passing through a particular operation, direct materials are different but conversion
costs (direct labor and manufacturing overhead) are the same.
o Exhibit 8.18 shows the flow of products through St. Ignace’s three departments,
Assembly, Painting, and Customization.
▪ Tigers pass through only the first two departments, where operations are identical for
both types of snowmobiles, but Ocelots pass through all three departments.
• Operation Costing Illustration
o Exhibit 8.19 shows the data on production and costs associated with this work order
COMPARING JOB, PROCESS, AND OPERATION COSTING
• Every company has its own unique costing methods that do not precisely fit any of these
three categories.
8–15
Matching
A.
Equivalent unit
E.
Prior department costs
B.
First-in, first-out FIFO process costing
F.
Production cost report
C.
Operation
G.
Weighted-average process costing
D.
Operation costing
_____ 1. An inventory costing method that combines costs and equivalent units of a period
with the costs and the equivalent units in beginning inventory from the last period.
_____ 2. Summarizes production and cost results for a period.
_____ 3. The manufacturing costs of units transferred out of one department and into a
subsequent department in the manufacturing process.
_____ 4. A hybrid of job and process costing that is used in manufacturing goods that have
some common characteristics and some individual characteristics.
_____ 5. A standardized method of making a product that is repeatedly performed.
_____ 6. An inventory costing method whereby the first goods received are the first ones
charged out when sold or transferred.
_____ 7. The number of complete physical units to which units in inventories are equal in
terms of work done to date.
8–16
Matching Answers
1. G
Multiple Choice
1. There are 2,000 units in the ending work-in-process inventory which are 65 percent complete
with respect to conversion costs. What are the equivalent units of production for the ending
inventory with respect to conversion?
a. 1,300 equivalent units.
b. 1,500 equivalent units.
c. 1,700 equivalent units.
d. 2,100 equivalent units.
Use the following information to answer questions 2 through 7:
At Mixing Department, all materials are added at the beginning of the process. Labor and
overhead (conversion resources) are added evenly throughout the process. The following
information pertains to the Mixing Department for the month of August.
Physical Units
Materials
Conversion
Beginning work-in-process
inventory
1,000 units
(60% complete)
$ 4,600
$ 2,340
Units started in August
6,000 units
Ending work-in-process inventory
800 units
(50% complete)
Costs added in August
40,200
49,800
2. How many units were completed and transferred out?
a. 4,100 units
b. 5,300 units
c. 5,900 units
d. 6,200 units
3. Using the weighted-average method, what is the conversion cost per equivalent unit?
a. $8.50
b. $8.10
c. $7.90
d. $7.50
4. Using the weighted-average method, what is the cost assigned to the ending work-in-process
inventory?
a. $5,780
b. $6,960
c. $7,640
d. $8,280
8–18
5. Using the FIFO method, what is the number of equivalent units for conversion?
a. 4,800
b. 5,400
c. 5,600
d. 6,000
6. Using the FIFO method, what is the conversion cost per equivalent unit?
a. $7.90
b. $8.30
c. $8.60
d. $9.10
7. Using the FIFO method, what is the cost assigned to the ending work-in-process inventory?
a. $8,280
b. $8,680
c. $9,140
d. $10,260
8. Which of the following statements is not correct?
a. Weighted-average costing does not separate beginning inventory from current period
activity.
b. As the product passes from one department to another, its costs must follow.
c. Equivalent whole units in terms of prior department costs cannot be determined.
d. The FIFO method results in unit costs that better reflect current costs.
9. Which of the following statements is correct?
a. Process costing assumes that each unit produced is relatively uniform.
b. Process costing maintains a detailed record of the cost of each unit produced.
c. Process costing provides as much information as job costing.
d. The difference between job costing and process costing is in the basic concepts.
10. Operation costing system:
a. Is a hybrid system.
b. Treats materials costs using job order costing method.
c. Treats conversion costs using process costing approach
d. All of the above.
11. Prior department costs are:
a. Also called transferred-in costs.
b. The manufacturing costs of units transferred from one department to another.
c. Treated as direct materials added at the beginning of the process.
d. All of the above.
12. Which of the following statements is correct?
a. In practice, only one of the production methods can be found.
b. An operation is a standardized method of making a product repeatedly performed.
c. Every company follows a standard costing method mandated by regulators.
d. The system that costs the most should be adopted because it provides the most accurate
information.
Multiple Choice Answers
8–21
8–22
Demonstration Problem 1
Process Excellence (PE), Inc. has two production departments: Mixing and Packaging.
Mixing
Department
Packaging
Department
Warehouse
At Mixing Department, all materials are added at the beginning of the process. Labor and
overhead (conversion resources) are added evenly throughout the process. The following
information pertains to the Mixing Department for the month of July.
Physical units
Materials
Conversion
Beginning work-in-process inventory
1,000 units
(40% complete)
$8,500
$7,552
Units started in July
5,000 units
Ending work-in-process inventory
400 units
(30% complete)
Costs added in July
60,500
130,872
Required:
1. Determine the number of units completed and transferred to the Packaging Department in
July.
2. Compute the equivalent units using the weighted-average method.
3. Compute the costs per equivalent unit using the weighted-average method.
4. Compute the costs of goods transferred out and the ending work-in-process inventory using
the weighted-average method.
8–23
Demonstration Problem 1 – Solution
Part 1
Work-in-Process Inventory
Beginning balance 1,000
Part 2
Since materials and conversion (labor and overhead) were added at different pace during the
production process, separate equivalent units have to be calculated, one for materials and the
other for conversion.
Physical Units
Conversion
Units transferred out
Total work
Part 3
Under the weighted-average method, the costs for current work and work in beginning work-in–
process inventory are combined. This total cost is then divided by the total equivalent units of
production for July.
Beginning work-in-process inventory
Current costs
Total costs
Total equivalent units
Cost per equivalent unit
Plus: Units started 5,000
Less: Units transferred out ?
Ending balance 400
8–24
Demonstration Problem 1 – Solution, continued
Part 4
Total
Costs
Materials
Costs
Conversion
Costs
Transferred out:
Equivalent units
5,600
5,600
Cost per equivalent unit
x $11.50
Cost assigned
$ 64,400
Ending WIP inventory:
Equivalent units
Cost per equivalent unit
x $11.50
Cost assigned
$ 4,600
Total costs assigned
$ 69,000
16,052
8–25
Demonstration Problem 2
(Continued from Demonstration Problem 1)
The information that pertains to the Mixing Department for the month of July is reproduced here.
All materials are added at the beginning of the process. Labor and overhead (conversion
resources) are added evenly throughout the process.
Physical Units
Materials
Conversion
Beginning work-in-process inventory
1,000 units
(40% complete)
$8,500
$7,552
Units started in July
5,000 units
Ending work-in-process inventory
400 units
(30% complete)
Costs added in July
60,500
130,872
Required:
1. Determine the number of units completed and transferred to the Packaging Department in
July.
2. Compute the equivalent units using the FIFO method.
3. Compute the cost per equivalent unit using the FIFO method.
4. Compute the costs of goods transferred out and the ending work-in-process inventory using
the FIFO method.
8–26
Demonstration Problem 2 – Solution
Part 1
Work-in-Process Inventory
Beginning balance 1,000
Part 2
Since materials and conversion (labor and overhead) were added at different paces during the
production process, separate equivalent units have to be calculated, one for materials and the
other for conversion.
Equivalent Units
Physical units
Materials
Conversion
To complete beginning WIP inventory
Units started and completed
Current work
a
Plus: Units started 5,000
Less: Units transferred out ?
Ending balance 400
Conversion
Current costs
$191,372
$60,500
Current equivalent units
Cost per equivalent unit
Demonstration Problem 2 – Solution, continued
Part 3
Under the FIFO method, current period costs are divided by the current equivalent units of
production in July to determine the cost per equivalent unit.
Part 4
Total
Costs
Materials
Costs
Conversion
Costs
Transferred out:
Costs from the beginning WIP inventory
$ 16,052
$ 8,500
$ 7,552
Current costs to complete beginning WIP inventory
14,760
0
Total costs from beginning WIP inventory
$ 30,812
$ 8,500
$ 22,312
Current costs of units started and completed
168,820
Cost assigned
$199,632
$64,160
Ending WIP inventory:
Cost assigned
7,792
Total costs assigned
$207,424
$69,000
7,792
8–28
Demonstration Problem 3
(Continued from Demonstration Problem 1)
Process Excellence (PE), Inc., has two production departments: Mixing and Packaging.
Mixing
Department
Packaging
Department
Warehouse
At the Packaging Department, all materials are added at the beginning of the process. Labor and
overhead (conversion resources) are added evenly throughout the process. The following
information pertains to the Packaging Department for the month of July.
Physical Units
Transferred-In
Materials
Conversion
Beginning work-in-process
inventory
900 units
(60% complete)
$10,680
$3,888
$5,130
Units completed
6,000 units
Ending work-in-process
inventory
500 units
(50% complete)
Costs added in July
199,920a
42,912
54,245
a This is the cost of goods completed and transferred out of the Mixing Department in July using
the weighted-average method.
Required:
1. Determine the number of units started in July.
2. Compute the equivalent units using the weighted-average method.
3. Compute the cost per equivalent unit using the weighted-average method.
4. Compute the costs of goods transferred out and the ending work-in-process inventory using
the weighted-average method.
8–29
Demonstration Problem 3 – Solution
Part 1
Work-in-Process Inventory
Part 2
Since materials and conversion (labor and overhead) were added at different paces during the
production process, separate equivalent units have to be calculated, one for materials and the
other for conversion. Transferred-in is considered an input added at the beginning of the
production process at the Packaging Department.
Equivalent Units
Physical
Units
Transferred-in
Materials
Conversion
Units transferred out
Total work
Beginning balance 900
Plus: Units started ?
Less: Units transferred out 6,000
Ending balance 500
8–30
Demonstration Problem 3 – Solution, continued
Part 3
Under the weighted-average method, the costs for current work and work in beginning work-in–
process inventory are combined. This total cost is then divided by the total equivalent units of
Part 4
Total Costs
Transferred-in
Materials
Conversion
Transferred out:
Equivalent units
6,000
6,000
6,000
Cost per equivalent unit
$ 32.40
Cost assigned
$194,400
Ending WIP inventory:
Equivalent units
Cost per equivalent unit
$ 32.40
Cost assigned
16,200
Total costs assigned
$210,600
Total Costs
Beginning WIP inventory
$ 10,680
Current costs
Total costs
$210,600
Total equivalent units
8–31
Demonstration Problem 4
Operations Excellence (OE), Inc. has two production departments: Mixing and Packaging.
Mixing
Department
Packaging
Department
Warehouse
OE manufactures two products: Compound H and Compound L. Compound H is a high-end
product that requires more expensive materials than Compound L and is produced at smaller
volume. The two products go through the two production departments in essentially the same
conversion processes. There is no work-in-process inventory for either product.
OE uses an operation costing system that assigns materials cost to the specific product for which
the underlying materials are used and assigns conversion costs to all products evenly as each
product undergoes the same process in each production department.
The production and cost data are available for July:
Compound H
Compound L
Total
2,500 Units
4,800 Units
Materials:
Mixing
$220,000
$100,000
$120,000
Packaging
75,900
37,500
38,400
Total materials cost
$295,900
$137,500
$158,400
Conversion:
Mixing
$219,000
Packaging
131,400
Total conversion cost
$350,400
Required:
Determine the unit cost for Compound H and Compound L.
Demonstration Problem 4 – Solution
For materials costs, the costing system at OE operates like a job order system. For conversion, a
process costing system is appropriate.
Compound H
Compound L
Total
2,500 Units
4,800 Units
Materials:
Mixing
$220,000
$100,000
$120,000
Packaging
75,900
37,500
38,400
Total materials cost
$295,900
$137,500
$158,400
Conversion:
Mixing
$219,000
$ 75,000
$144,000
Packaging
131,400
45,000
86,400
Total conversion cost
120,000
230,400
Total product cost
$646,300
Number of units
4,800
Cost per unit
$ 81
The conversion cost is assigned to the two products based on total units.
For Mixing Department:
Conversion cost for Compound L in the Mixing Department becomes: