PROCESS COSTING

INTRODUCTION
NATURE OF PROCESS COSTING

Process costing refers to the product costing procedure where products are assigned costs by department or
process. Cost accumulation and unit cost computation are by departments or processes. As goods are completed
in one department and transferred to the succeeding department, their assigned costs go with the physical
transfer until their completion and transfer to finished goods stockroom. Emphasis is on production for a given
period say, a week or a month instead of by orders or by lot.

APPLICATION OF PROCESS COST SYSTEM

Process costing is used for goods produced using continuous type of manufacturing process or under mass
production methods. The products are homogenous or do not have individual identities. Materials are places in
process in the first department and upon completion of the process in the said department, they are transferred to
the subsequent department or process and then to the next until they are in the form of finished goods ready for
sale.

TRACING COSTS IN A PROCESS COST SYSTEM

WORK IN PROCESS FINISHED GOODS

DEPARTMENT A DEPARTMENT B DEPARTMENT C STOREROOM
Direct Materials Cost Total Costs of Units received Total Costs of units received Finished Goods received from
+ Direct Labor Cost from Department A from Department B Department C
+ Overhead + Direct Materials + Direct Materials + Finished Goods Inventory
Total Costs of Department A + Direct Labor Costs + Direct Labor Costs Beginning
/ Equivalent Units Produced + Overhead + Overhead Total Cost of Goods Available
= Cost per Unit Total Costs of Department B Total Costs of Department C for Sale
X Units Transferred Out to / Equivalent Units Produced / Equivalent Units Produced
Department B = Costs per unit = Costs per unit
Total Cost of units transferred X Units Transferred to X Units Transferred to Finished
to Department B Department C Goods inventory
Total Costs of Units transferred Total Costs of Units transferred
to Department C to Finished Goods Inventory

PROCESS COST VS. JOB ORDER COST

ITEMS PROCESS COST JOB ORDER

1. Cost accumulation Per process or per department Per job, per order, per batch
2. Physical appearance Homogenous or similar Heterogenous or dissimilar
3. Manufacturing process Mass production Per specific job or per project
4. Cost Report Cost of Production Report Job Order Cost Sheet
5. Unit Cost Determination Total Cost Incurred/ Equivalent units of Total Costs incurred/ Total units produced
Production

The nature or operation to which process costing and job order costing is applied varies as indicated in the
following types of business activities in which they are adapted:

Process Cost Job Order Cost

Oil refineries Furniture
Plastic Automobile repair
Textiles Electrical Contractor
Cement Shipbuilding
Hollow blocks Jewelry making
Utilities
Newspaper publisher

EQUIVALENT UNITS OF PRODUCTION (EUP)

If the units placed in process are all completed at the end of the period, then the unit cost of production is
computed by merely dividing the total costs incurred by the total units produced. Normally, in a going concern,
units placed in process will not all be finished at the end of the production period. Usually, there will be units that
will be incomplete or still in process at the end of the period. Where there are units completed as well as units still
in process in the same period, then a costing problem will arise. How should the finished units and the incomplete
units be costed. Ordinarily they would not be given equal unit of costs for the reason that the time spent and cost
incurred for a finished unit are different from those incurred for an incomplete unit. For an equitable basis of
allocating costs to units completed and units still in process, it is necessary that the production of the period
should first be measured based on a common level of output. This approach is commonly known as equivalent
production or effective production or output divisor.

Illustration: Assume that 14,000 units were processed in Department B during the period. At the end of the
period, it was established that 8,000 units were completed and transferred to Department C while the remaining
6,000 units were still in process, estimated to be one-half (1/2) complete.

On the bases of one-half completion:

8,000 units x 2 16,000
6,000 units still in process 6,000
Equivalent Production 22,000

On the basis of Finished Units.

Complete units 8,000 x 100% 8,000
Incomplete units 6,000 x 50% 3,000
Equivalent Production 11,000

Of the two approaches shown above, the latter is the more convenient method. Thus, equivalent production can
be defined as the measure of work done in terms of finished units. In other words, these are the number of units
that would have been produced during the period assuming that all factors of production (materials, labor and
overhead) had been consumed.

For example, two units that are each half-complete would be treated as one complete unit for the purpose of
determining the cost per unit. The use of equivalent unit of production is peculiar to process cost system because
units produced under this system are in bid volume and possess identical characteristics, and therefore assumed to
have consumed the same amount of materials, labor and overhead.

APPLICATIONS OF THE ELEMENT OF COST TO PRODUCTION

There are two (2) methods of applying the elements of costs to production: Uniform or Even and the uneven
manner of application.

UNIFORM/ EVEN APPLICATION

Under this method, it is assumed that the materials, labor and overhead are applied uniformly or proportionately
from the start of the process up to the end. Such being the case, only one equivalent units of production is
determined and is applicable to all elements of cost.

Illustrative Problem:

Started in Process 10,000 units

Completed and transferred to the next department 7,000 units
Still in process at the end of the period (50% complete) 3,000 units
Total units accounted for 10,000 units

Costs:
Materials Php 12,750.00
Labor 7,650.00
Overhead 5,100.00
Total Php 25,500.00

Required:
1. Equivalent units of production
2. Compute the unit cost

Solution:
1. Computation of the Equivalent units of production

Work Done Equivalent Production

Units completed and transferred 7,000 100% 7,000
Units still in process 3,000 50% 1,500
8,500

2. Computation of Unit Cost

Total Costs Equivalent Production Unit Cost

 Materials Php 12,750.00 / 8,500 Php 1.50
Labor 7,650.00 / 8,500 0.90
Overhead 5,100 / 8,500 0.60
Total Php 25,500.00 Php 3.00

UNEVEN APPLICATION OF COSTS

In most manufacturing concerns, it is rate to find uniform application of costs. If ever, such assumptions may exist
only for the convenience of costing. In many instances, materials are added at the various points in manufacturing
process while labor and overhead are applied uniformly throughout the process. In other words, materials are not
applied in direct proportion to the manufacturing process but instead added in specific volume or quantities at
various stages of processing.

Case A. All materials are applied at the beginning of the process, while conversion costs are introduced
uniformly throughout the process.

Case B. All materials are given at the end of the process, while conversion costs are applied uniformly
throughout the process.

Case C. Materials are applied on installment basis through the process like 40% are introduced at the
start of the processing, 30% will then be added when the process is 50% complete and the
balance will finally be given when the process is ¾ complete. Conversion costs are applied
uniformly throughout the process.

Illustrative Problem:

Started in Process 40,000 units

Completed and transferred to the next department 30,000 units
Still in process at the end of the period 10,000 units
Total units accounted for 40,000 units

Required: Equivalent units of production under the different cases.

Solution:

Case A. All materials are applied at the beginning of the process, while conversion costs are introduced
uniformly throughout the process.

Actual Materials Conversion

Work Done Equivalent Production Work Done Equivalent Production
Units completed 30,000 100% 30,000 100% 30,000
Units still in process 10,000 100% 10,000 50% 5,000
Total units Accounted 40,000 40,000 35,000

Case B. All materials are given at the end of the process, while conversion costs are applied uniformly
throughout the process.

Actual Materials Conversion

Work Done Equivalent Production Work Done Equivalent Production
Units completed 30,000 100% 30,000 100% 30,000
Units still in process 10,000 0 0 50% 5,000
Total units Accounted 40,000 30,000 35,000

Case C. Materials are applied on installment basis through the process like 40% are introduced at the
start of the processing, 30% will then be added when the process is 50% complete and the
balance will finally be given when the process is ¾ complete. Conversion costs are applied
uniformly throughout the process.

Actual Materials Conversion

Work Done Equivalent Production Work Done Equivalent Production
Units completed 30,000 100% 30,000 100% 30,000
Units still in process 10,000 70% 7,000 50% 5,000
 Total units Accounted 40,000 37,000 35,000
*40% at the start of the
process
+ 30% when process is ½
complete
70%

The computation of equivalent units of production has been straightforward and simple, primarily because of
absence of work in process inventory beginning, thus all the units that were completed were assumed to have
been started in process during the current period.

FIRST-IN-FIRST-OUT (FIFO) VS. WEIGHTED AVERAGE

The presence of the beginning Work In Process inventory will have a significant bearing in the computation of the
equivalent units of production under the two methods of costing inventories.

FIFO METHOD

Under this method of costing, the cost of the beginning work in process inventory will be reported separately and
are assumed to have been completed ahead of the units that were started in the process in the current period.
The beginning work in process inventory therefore, will show separately the % of the work done in previous month
and the % of the work needed to compete in the current month.

Illustrative Problem:

The production data of Department A for the month of May show the following:

Units in process, May 1 (1/3 complete) 6,000

Units started in process during May 30,000
Units finished and transferred to the next department 28,000
Units still in process, May 31 (1/8 complete) 8,000

Equivalent units of production would be:

Actual Percent Work Done Equivalent Production

Work in process, May 1 6,000 2/3 4,000
Started in Process and completed this month
(30,000 – 8,000) 22,000 100% 22,000
Work in Process, May 31 8,000 1/8 1,000
36,000 27,000

Illustrative Problem:

Shown below is the production data for Department B for the month of May:

Units in process, May 1:

5,000 2/5 complete
4,000 ¾ complete
Units received from Department A 28,000
Units finished and transferred 30,000
Units in process, May 31:
4,000 1/2 complete
3,000 2/3 complete

Equivalent Units of Production would be:

Actual Percent Work Done Equivalent Production

Work in process, May 1 completed and
transferred 5,000 3/5 3,000
4,000 ¼ 1,000
Started in process, completed and
transferred 21,000 100% 21,000
(28,000 – 7,000)
Work in Process, May 31:
4,000 ½ 2,000
3,000 2/3 2,000
37,000 29,000
The computation of the equivalent units of production under FIFO method differs from the computation under the
weighted average method in two ways:
 First, the “units transferred” figure is divided into two parts: First part consists of the units from the
beginning inventory that were completed and transferred out while the other part consists of the units that were
started, completed and transferred during the current period.

Second, full consideration is given to the amount of work expended during the current period on units in
the beginning work in process inventory as well as those in the ending inventory. Thus, under the FIFO method it is
necessary to convert both inventories in terms of its equivalent units of production for the work done to bring it to
full completion, as the case maybe.

The EUP figure under the FIFO method will therefore consists of the following amounts:
1. The amount of work done to the units in the beginning inventory.
2. The amount of work done on the units that were started and completed during the current period.
3. The amount of work done on the units that were started in process during the current period but remain
incomplete at the end of the said period.

WEIGHTED AVERAGE METHOD

Unlike in the FIFO method, the weighted average method does not follow any assumed flow of costs with
reference to the beginning work in process inventory. In other words, once completed, the beginning inventory of
work in process will be reported as 100% work done in the current period regardless of the fact that this inventory
started in process in the previous month. Under this method, all units completed are assumed to have been
started and completed I the current period.

Illustrative Problem:

Work in process, July 1, 1/3 complete 15,000 units

Started in process during July 60,000 units
Finished and transferred to the next department 55,000 units
Work in process, July 31, ¼ complete 20,000 units

Required: compute the EUP under the weighted average method.

Solution:

Actual Percent Work Done Equivalent Production

Units completed and transferred 55,000 100% 55,000
Units still in process, July 31 20,000 ¼ 5,000
Total units accounted 75,000 60,000

Under the Weighted Average method, the equivalent unit of production consists of the all the units completed in
July plus the units still in process at the end.

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