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 operations 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
• Time Out! We Need to Make an Assumption about Costs and the Work-in-Process
Inventory
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
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. OPERATIONS COSTING
X. COMPARING JOB, PROCESS, AND OPERATIONS COSTING
Chapter Outline
• 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.
o Exhibit 8.1 provides a graphical comparison of typical cost flows in a job costing and in a
process costing system.
LO 8-1 Explain the concept and purpose of equivalent units.
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.
▪ Example 1: The Blending Department’s total output during the current period consists
of 6,000 physical units of ending work-in-process inventory which are 100 percent,
60 percent, and 75 percent complete as to materials, labor, and overhead, respectively.
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 costs to assign to products.
• 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:
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
▪ 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
• 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 ASJ’s Shredding Department is shown in Exhibit
8.5. (See Business Application box “Overstating Equivalent Units to Commit Fraud.”)
▪ Materials
▪ 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 × 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
o Exhibit 8.6 shows the costs for the Shredding Department in March.
• 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.
• This means that the ending work-in-process inventory comes from the units
started during the current period.
▪ Exhibit 8.7 shows the difference between weighted-average and FIFO process costing
unit cost computations by demonstrating the differences in aggregation.
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.
For each resource (i.e., materials and conversion):
• 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.
For each resource (i.e., materials and conversion):
Total cost assigned = (Units transferred out x cost per equivalent unit) + (Equivalent
units in ending work in process inventory with respect to that resource × cost per
equivalent unit with respect to that resource)
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.
Work-in-Process Inventory
See Demonstration Problem 1
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.
• 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.
• Sections 3, 4, and 5: Managing Costs
o Sections 3, 4, and 5 provide information about costs.
LO 8-5 Assign costs to products using first-in, first-out (FIFO) costing.
ASSIGNING COSTS USING FIRST-IN, FIRST-OUT (FIFO) PROCESS COSTING
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 2: Compute the equivalent units of production.
• 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
were started and completed in the current period. That is,
o Units completed and transferred out =
Units from the beginning work-in-process inventory + Units started and completed in
current period.
• 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:
• 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
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.
▪ If the department has no beginning inventory, then the weighted-average and FIFO
equivalent units are equal.
• Step 3: Identify the Product Costs for Which to Account
• Step 4: Compute the Costs per Equivalent Unit: FIFO
• Step 5: Assign Product Cost to Batches of Work: FIFO
• How This Looks in T-Accounts
o Exhibit 8.13 shows the flow of costs through the work-in-process T-account using the
FIFO method. The purpose is to provide an overview of the cost flows associated with
the process costing computations.
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.
o The FIFO method results in unit costs that better reflect current costs. For this reason,
FIFO costing generally offers greater decision-making benefits.
• Exhibit 8.14 compares the unit costs, costs transferred out, and ending work–in-process
inventory values under the two methods for ASJ’s Shredding 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.
o Prior department costs (or transferred-in costs) are the manufacturing costs of units
transferred out of one department and into a subsequent department in the manufacturing
process.
o Exhibit 8.16 shows the production cost report for the Pressing Department for March.
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.
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.
• Process costing assumes that all units produced are relatively uniform.
o Process costing does not maintain a record of the cost of each unit produced and therefore
has less detailed record-keeping.
▪ Process costing does not provide as much information as job costing.
LO 8-8 Compare and contrast operations costing with job costing and
process costing.
OPERATIONS COSTING
• Exhibit 8.17 shows a comparison of the three product costing methods.
• Operations costing is a hybrid of job and process costing that is used in manufacturing
goods that have some common characteristics and some individual characteristics.
• Product Costing in Operations
o The key difference between operations 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.
• Operations Costing Illustration
o Exhibit 8.19 shows the data on production and costs associated with this work order.
o Exhibit 8.20 shows the July costing summary for St. Ignace Sports Company.
o Exhibit 8.21 shows the flow of these costs through T-accounts to Finished Goods
Inventory.
See Demonstration Problem 4
COMPARING JOB, PROCESS, AND OPERATIONS COSTING
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.
Operations 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.
Matching Answers
1. G
3. E
5. C
7. A