ACC 123 – COST ACCOUNTING AND CONTROL – Hand-out 8.

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Topic: Process Costing Introduction (Notes)
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PROCESS COSTING

• The purpose of cost accounting is the “accumulation of data designed to provide management
with accurate information on the cost of manufacturing a product”. Its system for a
particular entity depends on the nature of manufacturing operations.
• If manufacturing process involves the continuous production of identical units rather than
distinguishable job lots, there can be no job orientation. When there is no obvious start
or finish (because the manufacturing process is endlessly repetitive), we use a process-
costing system to accumulate and allocate manufacturing costs.
o In using process costing, all manufacturing costs are allocated first to departments
or processes.
• Departmental or process costs are then allocated to units of product as units are completed.
Instead of using job-cost sheets, the costs associated with each department are summarized
on a cost-of-productions report with one report per department for a period of time.
o At the end of each period, the costs accumulated on each such report will be allocated
between end-of-period work in process and units transferred to the next process, or,
in the case of the final process, to finished goods.

Process Cost System

• This is the allocation of cost is by process.

• This determines how manufacturing costs incurred during cash period will be allocated.
• The goal is to compute total cost per unit for income determination.

Process Costing Methods

1. Industries producing chemicals, petroleum, textiles, steel, rubber, cement, flour,

pharmaceuticals, shoes, plastics, sugar, and coal.
2. Firms manufacturing items such as rivets, screws, bolts, and small electrical parts.
3. Assembly-type industry which manufactures typewriters, automobiles, airplanes, and
household electric appliances.
4. Service industries such as gas, water, and heat.

Characteristics of a Process Cost System

1. Costs are accumulated by department or cost center.

2. Each department has its own general ledger Work in Process Inventory account. This
account is debited with the processing costs incurred by the department and credited
with the cost of completed units transferred to another department or to finished goods
inventory.
3. Equivalent units are used to restate - work in process inventory to terms of completed
units at the end of the period.
4. Completed units and their corresponding costs are transferred to the last department or
to finished goods inventory. By the time units leave the last processing department,
total cost for the period have been accumulated and can be used to determine the unit
cost of each and total finished goods.
5. Total costs and unit costs for each department are periodically calculated and analyzed
with use of department cost of production report.

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Source:
Cost Accounting (2016) – De Leon, N., De Leon, E., & De Leon, G.
 ACC 123 – COST ACCOUNTING AND CONTROL – Hand-out 8.0
Topic: Process Costing Introduction (Notes)
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Comparison of Job Order Costing and Process Costing

Job Order Costing Process Costing

• This is most suitable when a single • This is used when products are
production of batch or products is manufactured by either mass production
manufactured according to a customer's techniques or continuous processing.
specifications. • This is suitable when homogeneous
products are manufactured in large
volume.

• The three elements cost (direct

• The three elements of a product's cost
materials, direct labor, and factory
(direct materials, direct labor, and
overhead) of a product's cost are
factory overhead) are accumulated
accumulated according to department or
according to identifiable jobs.
cost center.

• Individual work in process inventory • Individual work in process inventory

subsidiary cost sheets is set up for each accounts is set up for each department
and are charged with the cost incurred and are charged with the costs incurred
in the production of the specifically in the processing of the units that pass
ordered units. Upon completion of each through them. Upon completion of the
job, its cost is transferred from work process, the cost of work in process
in process to finished goods inventory. inventory in the last department is
transferred to finished goods inventory.

• The unit cost is computed upon the

• The unit cost is computed at the end of
completion of the job.
the month.

• Both require accumulating the costs of goods and services. But a key difference occurs
in computing unit costs. The unit cost of a product results from dividing the accumulated
cost by a measure of volume. The denominator under job order costing is the actual units
while under process costing, it is the equivalent units of production.
o Equivalent unit – the amount of work actually performed on products with varying
degrees of completion, translated to that work required to complete an equal number
of whole units.

System Flow

• Units and costs flow together through a process cost system. The following equation
summarizes the physical flow of units in the department:

Units to account for: Units accounted for:

Beginning units in process Units completed and
+ = transferred
+

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Source:
Cost Accounting (2016) – De Leon, N., De Leon, E., & De Leon, G.
 ACC 123 – COST ACCOUNTING AND CONTROL – Hand-out 8.0
Topic: Process Costing Introduction (Notes)
REV: 1
Units started in process or Units completed and on hand
received from previous +
department Units in process end
+
Increase in units due to
addition of materials

Product Flow

• Sequential product flow – initial raw materials are placed into process in the first
department and flow through every department in the factory. Additional materials may
or may not be added in the subsequent departments. All items purchased go through the
same processes in the same sequence.
• Parallel product flow – certain portions of the work are done at the same time and then
brought together for the final process and upon completion transferred to finished goods
inventory.
• Selective – the product moves to different departments within the factory, depending
upon the desired final product. Several products are produced from the same initial raw
materials.

Direct Materials

• These are always added in the first processing department but they are also usually
added in other departments. The journal entry would be the same for adding direct
material cost in later processing departments. The accumulation of direct material cost
is much simpler in a process cost system than in a job order cost system. Fewer journal
entries are generally required under process cost system.

Direct Labor

• The amounts to be charged to each department are determined by the gross earnings of the
employees assigned to each department. Process costing reduces the amount of paperwork
needed to assign labor costs.

Factory Overhead

• The costs may be applied using either of the following two methods. The first method
which is like that used in job order costing applies factor overhead to work-in-process
inventory at a predetermined application rate. A predetermined factory overhead
application rate based on normal capacity is appropriate when production volume or factor
overhead costs fluctuate substantially from month to month as it eliminates distortion
m monthly unit costs caused by such fluctuations. The second method charges actual
factory costs incurred to work in process inventory. When production volume and factory
overhead costs remain relatively constant from month to month, expected capacity is
appropriate as the denominator activity level. In a process cost system, where there is
continuous production, either method maybe used.

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Source:
Cost Accounting (2016) – De Leon, N., De Leon, E., & De Leon, G.
 ACC 123 – COST ACCOUNTING AND CONTROL – Hand-out 8.0
Topic: Process Costing Introduction (Notes)
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The Cost of Production Report

• This is an analysis of the activity in the department or cost center for the period. All
costs chargeable to a department or cost center are presented according to cost elements.
• Total and unit costs are determined and summarized on a cost of production report.
• Either each cost center or department makes such a report, or the individual reports of
several departments are summarized.
• This is to emphasize is that process costing requires an orderly approach to assigning
costs to products.

The following steps provide a uniform approach in preparing the cost of production report.

Step 1 - The Quantity Schedule

This schedule accounts for the physical flow of units into and out of departments.

All units started in the department must be accounted for and also the disposition of these units.
that is, whether they are transferred to the next department, lost, or remain in the department
(complete or incomplete). This schedule is concerned only with Whole units, regardless of their
stages of completion.

Step 2 - Calculate Equivalent Units and Unit Costs

All units must be expressed in terms of completed units to determine unit costs. Equivalent
production equals total units completed plus incomplete units restated in terms of completed units.
Incomplete units are accounted for in work in process inventory until they are completed and
transferred to finished goods inventory. Therefore, to compute equivalent production, an analysis
must be made of the stage of completion of/work in process inventory: subdivided into direct
materials, direct labor, and factory overhead. The unit cost in the department is computed by
dividing the cost incurred in the department for each element by the equivalent production. The
formula is:

FIRST-IN FIRST-OUT METHOD

Equivalent unit cost = Costs added during the period/Equivalent Units (Work done this
period)

WEIGHTED AVERAGE METHOD

Equivalent Unit Cost = (Cost last period plus cost added this period)/Equivalent Units

(Work done last period plus work done this period)

Step 3 - Determine the costs to be accounted for (costs charged to the department)

The cost that a department is responsible for may come from several sources. For one thing, there
may be some units in beginning inventory that may be partially complete; and the costs of direct
materials, direct labor, and factory overhead that were assigned to these units last period will
become the cost of the beginning inventory and must be accounted for. Also, if the department is
not the first department in the production process, it will receive costs from other departments
when the units from these departments are received in its operations. In addition, each department

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Source:
Cost Accounting (2016) – De Leon, N., De Leon, E., & De Leon, G.
 ACC 123 – COST ACCOUNTING AND CONTROL – Hand-out 8.0
Topic: Process Costing Introduction (Notes)
REV: 1
will incur direct materials, direct labor, and factory overhead in its own processing. The total
of these costs must be determined so that they can be accounted for.

Step 4 - Account for all costs

After the costs for which the department, is responsible for are determined, an accounting for
the disposition of these costs must be made. Some of the costs are assigned to cost centers
receiving units transferred' out of the department. The remaining costs are assigned t the units
remaining in the department and, in some cases, to any units lost.

Methods of Costing Under Process Costing

1. FIFO Method
Under this method there is an assumed flow of manufacturing operations and as such it is
considered that those units which are first placed in process are presumed to be the first
ones completed and those that are first completed are the ones transferred out.

Characteristics:
a. The work in process beginning in the department will require a separate computation for
its equivalent production.
b. The units started, completed, and transferred will have its own computation for
equivalent production.
2. Weighted Average Method
Under this method, there is no assumed flow of manufacturing operations. It involves the
merging of the departmental costs, by elements, of the initial work in process inventory
with the costs incurred in the current month and securing a representative average unit
cost by dividing the total element of costs by the equivalent production based upon the sum
of the units in the initial work in process inventory and the units placed into production
during the period.

Characteristics:
a. In the computation of the equivalent production, the stage of completion of the work in
process beginning is ignored and the total units completed and transferred during the
period is considered to have 100% completion.

Methods of Application of Elements of Cost to Production

1. Even application - under this method, it is considered that at any stage during the process
of production, the introduction of the three elements of cost is equal with one another.
Only one computation of equivalent production should be made.
2. Uneven application - under this method, the introduction of the elements of cost to
production varies at any stage of the process, hence, there should be as many computations
of equivalent as the elements of cost that are unevenly applied.

ILLUSTRATIVE PROBLEM
The following data were taken from the books of Michelle Co. for the month of June:

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Source:
Cost Accounting (2016) – De Leon, N., De Leon, E., & De Leon, G.
 ACC 123 – COST ACCOUNTING AND CONTROL – Hand-out 8.0
Topic: Process Costing Introduction (Notes)
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Department 1 Department 2
Units
Started 25,000
Completed & Transferred 20,000 18,000
In process, end. 5,000 2,000
Stage of completion 40% 50%
Costs
Materials 100,000 54,000
Labor 66,000 38,000
Overhead 44,000 19,000

In Department 1, materials are added at the beginning of the process while in Department 2,
materials are added at the end of the process.

Requirement:
1. Prepare cost of production report for June 2016.
2. Prepare necessary journal entries for June 2016.
3. Prepare cost of goods manufactured statement June 2016.

- END OF HAND-OUT -

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Source:
Cost Accounting (2016) – De Leon, N., De Leon, E., & De Leon, G.