Cost Accounting

Seventeenth Edition, Global Edition

Chapter 18
Process Costing

Copyright © 2021 Pearson Education Ltd.

Learning Objectives (1 of 2)
18.1 Identify the situations in which process-costing systems
are appropriate
18.2 Understand the basic concepts of process-costing and
compute average unit costs
18.3 Describe the five steps in process-costing and calculate
equivalent units
18.4 Use the weighted-average method and first-in, first-out
(FI F O) method of process costing

Copyright © 2021 Pearson Education Ltd.

Learning Objectives (2 of 2)
18.5 Apply process-costing methods to situations with
transferred-in costs
18.6 Understand the need for hybrid-costing systems such
as operation costing

Copyright © 2021 Pearson Education Ltd.

Job Versus Process-Costing
Job-costing systems Process-costing systems
• Distinct, identifiable units of • Masses of identical or
a product or service similar units of a product or
• Examples: service
– Custom-made • Examples:
machines, houses – Food, chemical
processing

Copyright © 2021 Pearson Education Ltd.

Process Costing
• Process costing is a system where the unit cost of a
product or service is obtained by assigning total costs to
many identical or similar units of output.
• Unit costs are calculated by dividing total costs incurred by
the number of units of output from the production process.
• Each unit receives the same or similar amounts of direct
materials costs, direct manufacturing labor costs, and
indirect manufacturing costs (manufacturing overhead).

Copyright © 2021 Pearson Education Ltd.

More on Job- Versus Process-
Costing
• In a job-costing system, individual jobs use different
quantities of resources, so it would be incorrect to cost
each job at the same average production cost.
• In contrast, when identical or similar units of products or
services are mass-produced, process costing is used to
calculate an average production cost for all units produced.
• The main difference between process costing and job
costing is the extent of averaging used to compute the unit
costs of products or services.

Copyright © 2021 Pearson Education Ltd.

Process-Costing Cost Categories
Process-costing systems separate costs into cost categories
according to when costs are introduced into the process.
1. Direct materials are usually added at the beginning of the
production process, or at the start of work in a
subsequent department down the assembly line.
2. Conversion costs are generally added equally along the
production process.

Copyright © 2021 Pearson Education Ltd.

Process-Costing: Three Cases
Let’s look at the process-costing process three ways:
Case 1: No beginning or ending work-in-process inventories
Case 2: No beginning work-in-process inventory and some
ending work-in-process inventory
Case 3: Both beginning and ending work-in-process
inventories are present

Copyright © 2021 Pearson Education Ltd.

Case 1: No Beginning or Ending
Work-in-Process Inventory (1 of 3)
When using process costing without any beginning or ending
work-in-process inventory, all costs that were introduced to
the process during the period will be assigned to the finished
units leaving work-in-process inventory at the end of the
period.

Copyright © 2021 Pearson Education Ltd.

Case 1: No Beginning or Ending
Work-in-Process Inventory (2 of 3)
Five-Step Process-Costing Allocation
1. Summarize the flow of physical units of output.
2. Compute output in terms of equivalent units.
3. Summarize total costs to account for.
4. Compute cost per equivalent unit.
5. Assign total costs to units completed and to units in
ending work-in-process.

Copyright © 2021 Pearson Education Ltd.

Case 1: No Beginning or Ending
Work-in-Process Inventory (3 of 3)
Equivalent Units
• A derived amount of output units that
– takes the quantity of each input in units completed and
in unfinished units of work in process and
– converts the quantity of input into the amount of
completed output units that could be produced with that
quantity of input.
• They are calculated separately for each input (direct
materials and conversion cost).
• When calculating equivalent units in step 2, focus on
quantities and disregard dollar amounts until after the
equivalent units are computed.
Copyright © 2021 Pearson Education Ltd.
Case 2: No Beginning, Some Ending
W I P Steps 1 and 2 Example
Exhibit 18.1 Summarize the Flow of Physical Units and Compute Output in
Equivalent Units for the Assembly Department

Copyright © 2021 Pearson Education Ltd.

Case 2: No Beginning, Some Ending
W I P Steps 3, 4, and 5 Example
Exhibit 18.2 Summarize the Total Costs to Account for, Compute the Cost per
Equivalent Unit, and Assign Costs to the Units Completed and Units in Ending
Work-in-Process Inventory for the Assembly Department

Copyright © 2021 Pearson Education Ltd.

General Ledger Cost Flows Illustrated
Exhibit 18.3 Flow of Costs in a Process-Costing System for the Assembly
Department

Copyright © 2021 Pearson Education Ltd.

Weighted-Average Process-Costing
Method (1 of 2)
Process costing can be accomplished using the weighted-
average method or the F I F O method. We’ll look first at
weighted-average.
Weighted-Average Method
• Calculates cost per equivalent unit of all work done to date
(regardless of the accounting period in which it was done)
• Assigns this cost to equivalent units completed and
transferred out of the process and to equivalent units in
ending work-in-process inventory

Copyright © 2021 Pearson Education Ltd.

Weighted-Average Process-Costing
Method (2 of 2)
• The weighted-average cost is the total of all costs entering
the work-in-process account divided by the total equivalent
units of work done to date.
• The beginning balance of the work-in-process account
(work done in a prior period) is blended in with current
period costs.
• Let’s look at Case 3 (with both beginning and ending work-
in-process inventory using the weighted average method).

Copyright © 2021 Pearson Education Ltd.

Case 3: Beginning and Ending WI P
Steps 1 and 2 Example (1 of 2)
Exhibit 18.4 Summarize the Flow of Physical Units and Compute Output in
Equivalent Units Using the Weighted-Average Method for the Assembly
Department

Copyright © 2021 Pearson Education Ltd.

Case 3: Beginning and Ending W I P
Steps 3, 4, and 5 Example (1 of 2)
Exhibit 18.5 Summarize the Total Costs to Account for, Compute the Cost per
Equivalent Unit, and Assign Costs to the Units Completed and Units in Ending
Work-in-Process Inventory Using the Weighted-Average Method for the
Assembly Department

Copyright © 2021 Pearson Education Ltd.

Results of the Process
Two critical figures arise out of step 5 of the cost allocation
process:
1. The amount of the journal entry transferring the
allocated cost of units completed and sent from work-
in-process inventory to finished goods inventory
2. The ending balance of the work-in-process inventory
account that will appear on the balance sheet

Copyright © 2021 Pearson Education Ltd.

First-In, First-Out (FIF O) Process-
Costing Method (1 of 2)
• Assigns the cost of the previous accounting period’s
equivalent units in beginning work-in-process inventory to
the first units completed and transferred out of the process
• Assigns the cost of equivalent units worked on during the
current period first to complete beginning inventory, next to
started and completed new units, and finally to units in
ending work-in-process inventory

Copyright © 2021 Pearson Education Ltd.

First-In, First-Out (FIF O) Process-
Costing Method (2 of 2)
• A distinctive feature of F I F O process-costing method is
that work done on the beginning inventory before the
current period is kept separate from work done in the
current period.
• The costs incurred and units produced in the current
period are used to calculate the cost per equivalent unit of
work done in the current period.
• In contrast, the equivalent-unit and cost per equivalent unit
calculations under the weighted-average method M ERG E
the units and costs in beginning inventory with the units
and costs of work done in the current period.

Copyright © 2021 Pearson Education Ltd.

Case 3: Beginning and Ending W I P
Steps 1 and 2 Example (2 of 2)
Exhibit 18.6 Summarize the Flow of Physical Units and Compute Output in
Equivalent Units Using the FIF O Method for the Assembly Department

Copyright © 2021 Pearson Education Ltd.

Case 3: Beginning and Ending WI P
Steps 3, 4, and 5 Example (2 of 2)
Exhibit 18.7 Summarize the Total Costs to Account for, Compute the Cost per
Equivalent Unit, and Assign Costs to the Units Completed and Units in Ending
Work-in-Process Inventory Using the F I F O Method for the Assembly Department

Copyright © 2021 Pearson Education Ltd.

Comparing Weighted-Average and FIF O
Methods (1 of 2)
• FI F O assumes that all the units from the previous period
(higher cost units in our example) in beginning W I P are
the first to be completed and transferred out and that
ending W I P consists of only the lower cost current-period
units.
• The weighted-average method smooths out the cost per
equivalent unit by assuming that more lower cost units are
transferred out and some higher cost remain in ending
W I P.

Copyright © 2021 Pearson Education Ltd.

Comparing Weighted-Average and FIF O
Methods (2 of 2)
• Managers use information from process-costing systems
to make pricing and product-mix decisions and understand
how well a firm’s processes are performing.
• FI F O provides managers with information about changes
in the costs per unit from one period to the next.
• In a period of rising prices, the weighted-average method
will decrease taxes because cost of goods sold will be
higher and operating income lower.

Copyright © 2021 Pearson Education Ltd.

Transferred-In Costs
• Transferred-in costs are costs incurred in previous
departments that are carried forward as the product’s cost
when it moves to a subsequent process in the production
cycle.
• They are also called previous department costs.
• Journal entries are made to mirror the progress in
production from department to department.
• Transferred-in costs are treated as if they are a separate
type of direct material added at the beginning of the
process.

Copyright © 2021 Pearson Education Ltd.

Steps 1 and 2 Example for Beginning
and Ending WI P and Transferred-in
Costs: Weighted Average Method
Exhibit 18.8 Summarize the Flow of Physical Units and Compute Output in
Equivalent Units Using the Weighted-Average Method for the Testing Department

Copyright © 2021 Pearson Education Ltd.

Steps 3, 4, and 5 Example for Beginning
and Ending WI P and Transferred-In
Costs: Weighted Average Method
Exhibit 18.9 Summarize the Total Costs to Account for, Compute the Cost per
Equivalent Unit, and Assign Costs to the Units Completed and Units in Ending W I
P Inventory Using the Weighted-Average Method for the Testing Department

Copyright © 2021 Pearson Education Ltd.

Steps 1 and 2 Example for Beginning
and Ending WI P and Transferred-In
Costs: FIF O Method
Exhibit 18.10 Summarize the Flow of Physical Units and Compute Output in
Equivalent Units Using the F I F O Method for the Testing Department

Copyright © 2021 Pearson Education Ltd.

Steps 3, 4, and 5 Example for Beginning
and Ending WI P and Transferred-In Costs:
FIF O Method
Exhibit 18.11 Summarize the Total Costs to Account for, Compute the Cost per
Equivalent Unit, and Assign Costs to the Units Completed and Units in Ending W
I P Inventory Using the FIF O Method for the Testing Department

Copyright © 2021 Pearson Education Ltd.

Points to Remember About
Transferred-In Costs (1 of 2)
1. Be sure to include the transferred-in costs from previous
departments in your calculations.
2. When calculating the costs to be transferred using the
FI F O method, do not overlook costs assigned in the
previous period to units that were in process at the
beginning of the current period but are now included in
the units transferred.
These unit costs will be transferred to the next
department at ONE AVERAGE UNIT cost.

Copyright © 2021 Pearson Education Ltd.

Points to Remember About
Transferred-In Costs (2 of 2)
3. Unit costs may fluctuate between periods so transferred
units may contain batches accumulated at different costs
(using FI F O).
4. Units may be measured in different denominations in
different departments (feet in one department and yards
in another or kilos versus liters). In this case,
measurements must be converted to the correct
measure.

Copyright © 2021 Pearson Education Ltd.

Hybrid Costing Systems (1 of 2)
• Product-costing systems do not always fall neatly into
either job-costing or process-costing categories.
• A hybrid-costing system blends characteristics from both
job-costing and process-costing systems.
• Many actual production systems are in fact hybrids.
• Manufacturers who tend to use hybrid-costing systems
include producers of televisions, dishwashers, washing
machines, and shoes.

Copyright © 2021 Pearson Education Ltd.

Hybrid Costing Systems (2 of 2)
• The hybrid-costing systems use process costing to
account for the conversion costs and job costing for the
material and customizable components.
• One specific type of hybrid-costing system is known as the
operation costing system.

Copyright © 2021 Pearson Education Ltd.

Operation Costing System
• An operation is a standardized method or technique often
performed repetitively on different material resulting in
different finished goods.
• An operation-costing system is a hybrid-costing system
applied to batches of similar, but not identical, products.
• Within each operation, all product units are treated exactly
alike, using identical amounts of the operation’s resources.
• Managers find operation costing useful in cost
management because operation costing focuses on
control of physical processes or operations of a given
production system.

Copyright © 2021 Pearson Education Ltd.

Terms to Learn
Equivalent units
First-in, first-out (FIF O) process-costing method
Hybrid-costing system
Operation
Operation costing system
Previous department cost
Transferred-in cost
Weighted-average process-costing method

Copyright © 2021 Pearson Education Ltd.