Chapter 4
System Design:
Process Costing
PowerPoint Authors:
Jon A. Booker, Ph.D., CPA, CIA
Charles W. Caldwell, D.B.A., CMA
Susan Coomer Galbreath, Ph.D., CPA
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
4-2
Similarities Between Job-Order
and Process Costing
• Both systems assign material, labor and
overhead costs to products and they provide a
mechanism for computing unit product cost.
• Both systems use the same manufacturing
accounts, including Manufacturing Overhead,
Raw Materials, Work in Process, and Finished
Goods.
• The flow of costs through the manufacturing
accounts is basically the same in both systems.
4-3
Differences Between Job-Order
and Process Costing
• Process costing is used when a single product is
produced on a continuing basis or for a long
period of time. Job-order costing is used when
many different jobs are worked on each period.
• Process costing systems accumulate costs by
department. Job-order costing systems
accumulate costs by individual jobs.
• Process costing systems compute unit costs by
department. Job-order costing systems compute
unit costs by job on the job cost sheet.
4-4
Quick Check

Process costing is used for products that are:
a. Different and produced continuously.
b. Similar and produced continuously.
c. Individual units produced to customer
specifications.
d. Purchased from vendors.
4-5
Quick Check

Process costing is used for products that are:
a. Different and produced continuously.
b. Similar and produced continuously.
c. Individual units produced to customer
specifications.
d. Purchased from vendors.
4-6
Processing Departments
Any location in an organization where materials,
labor, or overhead are added to the product.
The activities performed in a processing
department are performed uniformly on all
units of production. Furthermore, the output
of a processing department must be
homogeneous.
4-7
Learning Objective 1
Record the flow
of materials, labor, and
overhead through a
process costing system.
4-8
Flow of Materials, Labor, and
Overhead Costs
Direct
Materials
Direct Labor
Manufacturing
Overhead
Work in
Process
Finished
Goods
Cost of
Goods
Sold
4-9
Flow of Materials, Labor, and
Overhead Costs
Costs are traced and
applied to individual
jobs in a job-order
cost system.
Direct
Materials
Direct Labor
Manufacturing
Overhead
Jobs
Finished
Goods
Cost of
Goods
Sold
4-10
Flow of Materials, Labor, and
Overhead Costs
Direct
Materials
Direct Labor
Manufacturing
Overhead
Costs are traced and
applied to departments
in a process cost
system.
Processing
Department
Finished
Goods
Cost of
Goods
Sold
4-11
T-Account and Journal Entry
Views of Process Cost Flows
For purposes of this
example, assume there are
two processing departments
– Departments A and B.
We will use T-accounts and
journal entries.
4-12
The Flow of Raw Materials
(in T-Account form)
Raw Materials
•Direct
Materials
Work in Process
Department A
•Direct
Materials
Work in Process
Department B
•Direct
Materials
4-13
The Flow of Raw Materials
(in journal entry form)
GENERAL JOURNAL
Date
Description
Post.
Ref.
Page 4
Debit
Work in Process - Department A
XXXXX
Work in Process - Department B
XXXXX
Raw Materials
To record the use of direct material.
Credit
XXXXX
4-14
The Flow of Labor Costs
(in T-Account form)
Salaries and
Wages Payable
•Direct
Labor
Work in Process
Department A
•Direct
Materials
•Direct
Labor
Work in Process
Department B
•Direct
Materials
•Direct
Labor
4-15
The Flow of Labor Costs
(in journal entry form)
GENERAL JOURNAL
Date
Description
Post.
Ref.
Page 4
Debit
Work in Process - Department A
XXXXX
Work in Process - Department B
XXXXX
Salaries and Wages Payable
To record direct labor costs.
Credit
XXXXX
4-16
The Flow of Manufacturing Overhead Costs
(in T-Account form)
Work in Process
Department A
Manufacturing
Overhead
•Actual
Overhead
•Overhead
Applied to
Work in
Process
•Direct
Materials
•Direct
Labor
•Applied
Overhead
Work in Process
Department B
•Direct
Materials
•Direct
Labor
•Applied
Overhead
4-17
The Flow of Manufacturing Overhead Costs
(in journal entry form)
GENERAL JOURNAL
Date
Description
Post.
Ref.
Page 4
Debit
Work in Process - Department A
XXXXX
Work in Process - Department B
XXXXX
Manufacturing Overhead
To apply overhead to departments.
Credit
XXXXX
4-18
Partially Completed Units Transferred
(in T-Account form)
Work in Process
Department A
•Direct
Materials
•Direct
Labor
•Applied
Overhead
Transferred
to Dept. B
Work in Process
Department B
•Direct
Materials
•Direct
Labor
•Applied
Overhead
•Transferred
from Dept. A
4-19
Partially Completed Units Transferred
(in journal entry form)
GENERAL JOURNAL
Date
Description
Work in Process - Department B
Work in Process - Department A
To record the transfer of goods from
Department A to Department B.
Post.
Ref.
Page 4
Debit
Credit
XXXXX
XXXXX
4-20
Transfer of Cost of Completed Units
(in T-Account form)
Work in Process
Department B
•Direct
•Cost of
Materials
Goods
•Direct
Manufactured
Labor
•Applied
Overhead
•Transferred
from Dept. A
Finished Goods
•Cost of
Goods
Manufactured
4-21
Transfer of Cost of Completed Units
(in journal entry form)
GENERAL JOURNAL
Date
Description
Finished Goods
Work in Process - Department B
To record the completion of goods
and their transfer from Department B
to finished goods inventory.
Post.
Ref.
Page 4
Debit
Credit
XXXXX
XXXXX
4-22
Cost of Finished Goods Sold
(in T-Account form)
Work in Process
Department B
Finished Goods
•Direct
•Cost of
•Cost of
•Cost of
Materials
Goods
Goods
Goods
•Direct
Manufactured
Manufactured
Sold
Labor
•Applied
Overhead
•Transferred
from Dept. A
Cost of Goods Sold
•Cost of
Goods
Sold
4-23
Cost of Finished Goods Sold
(in journal entry form)
GENERAL JOURNAL
Date
Description
Cost of Goods Sold
Finished Goods
To record cost of goods sold.
Post.
Ref.
Page 4
Debit
Credit
XXXXX
XXXXX
4-24
Equivalent Units of Production
Equivalent units are the product of the number
of partially completed units and the percentage
of completion of those units.
We need to calculate equivalent units because a
department usually has some partially completed
units in its beginning and ending inventory.
4-25
Equivalent Units – The Basic Idea
Two half completed products are
equivalent to one completed product.
+
=
1
So, 10,000 units 70% complete
are equivalent to 7,000 complete units.
4-26
Quick Check

For the current period, Jones started 15,000
units and completed 10,000 units, leaving
5,000 units in process that are 30 percent
complete. How many equivalent units of
production did Jones have for the period?
a. 10,000
b. 11,500
c. 13,500
d. 15,000
4-27
Quick Check

For the current period, Jones started 15,000
units and completed 10,000 units, leaving
5,000 units in process that are 30 percent
complete. How many equivalent units of
production did Jones have for the period?
a. 10,000
10,000 units + (5,000 units × 0.30)
b. 11,500
= 11,500 equivalent units
c. 13,500
d. 15,000
4-28
Calculating Equivalent Units
Equivalent units can be calculated two
ways:
The First-In, First-Out Method – FIFO
is covered in the appendix available on the web.
The Weighted-Average Method – This
method will be covered in the main portion of
the chapter.
4-29
Learning Objective 2
Compute the equivalent
units of production using the
weighted-average method.
4-30
Characteristics of the Weighted
Average Method
The weighted-average method . . .
• Makes no distinction between work done in
prior or current periods.
• Blends together units and costs from prior
and current periods.
The equivalent units of production for a
department are the number of units transferred
to the next department (or Finished Goods) plus
the equivalent units in the department’s ending
Work in Process inventory.
4-31
Treatment of Direct Labor
Dollar Amount
Direct
Materials
Direct
Labor
Direct labor costs
may be small
in comparison to
Conversion
other product
costs in process
costing systems.
Type of Product Cost
4-32
Treatment of Direct Labor
Dollar Amount
Direct
Materials
Direct labor costs
may be small
Conversion
in comparison to
other product
costs in process
costing systems.
Type of Product Cost
Direct labor and manufacturing overhead may be
combined into one product cost called conversion.
4-33
Weighted-Average – An Example
Smith Company reported the following activity in
the Assembly Department for the month of June:
Percent Completed
Units
Work in Process, June 1
300
Units started into production in June
6,000
Units completed and transferred out
of Department A during June
5,400
Work in Process, June 30
900
Materials Conversion
40%
20%
60%
30%
4-34
Weighted-Average – An Example
The first step in calculating the equivalent units is to identify
the units completed and transferred out of Assembly
Department in June (5,400 units)
Materials
Units completed and transferred
out of the Department in June
5,400
Conversion
5,400
4-35
Weighted-Average – An Example
The second step is to identify the equivalent units of
production in ending work in process with respect to
materials for the month (540 units) and adding this to the
5,400 units from step one.
Materials
Units completed and transferred
out of the Department in June
5,400
Work in Process, June 30:
900 units × 60%
Equivalent units of Production in
the Department during June
540
5,940
Conversion
5,400
4-36
Weighted-Average – An Example
The third step is to identify the equivalent units of production in
ending Work in Process with respect to conversion for the
month (270 units) and adding this to the 5,400 units from step
one.
Materials
Units completed and transferred
out of the Department in June
5,400
Conversion
5,400
Work in Process, June 30:
900 units × 60%
540
270
900 units × 30%
Equivalent units of Production in
the Department during June
5,940
5,670
4-37
Weighted-Average – An Example
Equivalent units of production always equals:
Units completed and transferred
+ Equivalent units remaining in Work in Process
Materials
Units completed and transferred
out of the Department in June
5,400
Conversion
5,400
Work in Process, June 30:
900 units × 60%
540
270
900 units × 30%
Equivalent units of Production in
the Department during June
5,940
5,670
4-38
Weighted-Average – An Example
Materials
Beginning
Work in Process
300 Units
40% Complete
6,000 Units Started
5,100 Units Started
and Completed
5,400 Units Completed
540 Equivalent Units
5,940 Equivalent units
of production
Ending
Work in Process
900 Units
60% Complete
900 × 60%
4-39
Weighted-Average – An Example
Conversion
Beginning
Work in Process
300 Units
20% Complete
6,000 Units Started
5,100 Units Started
and Completed
5,400 Units Completed
270 Equivalent Units
5,670 Equivalent units
of production
Ending
Work in Process
900 Units
30% Complete
900 × 30%
4-40
Learning Objective 3
Compute the cost per equivalent
unit using the weighted-average
method.
4-41
Compute and Apply Costs
Beginning Work in Process Inventory:
400 units
Materials: 40% complete $
6,119
Conversion: 20% complete $
3,920
Production started during June
Production completed during June
Costs added to production in June
Materials cost
Conversion cost
Ending Work in Process Inventory:
Materials:
60% complete
Conversion: 30% complete
6,000 units
5,400 units
$ 118,621
$ 81,130
900 units
4-42
Compute and Apply Costs
The formula for computing the cost per
equivalent unit is:
Cost per
equivalent =
unit
Cost of beginning
Work in Process + Cost added during
inventory
the period
Equivalent units of production
4-43
Compute and Apply Costs
Here is a schedule with the cost and equivalent
unit information.
Total
Cost
Cost to be accounted for:
Work in Process, June 1
Cost added in Assembly
Total cost
Equivalent units
Materials
Conversion
$
10,039
199,751
$
6,119
118,621
$
3,920
81,130
$
209,790
$ 124,740
$
85,050
5,940
5,670
4-44
Compute and Apply Costs
Here is a schedule with the cost and equivalent
unit information.
$124,740 ÷ 5,940 units = $21.00
$85,050 ÷ 5,670 units = $15.00
Total
Cost
Cost to be accounted for:
Work in Process, June 1
Cost added in Assembly
Total cost
Materials
Conversion
$
10,039
199,751
$
6,119
118,621
$
3,920
81,130
$
209,790
$ 124,740
$
85,050
Equivalent units
Cost per equivalent unit
5,940
$
21.00
5,670
$
15.00
Cost per equivalent unit = $21.00 + $15.00 = $36.00
4-45
Learning Objective 4
Assign costs to units using the
weighted-average method.
4-46
Applying Costs
Assembly Department
Cost of Ending WIP Inventory and Units Transferred Out
Materials Conversion
Total
Ending WIP inventory:
Equivalent units
540
270
4-47
Applying Costs
Assembly Department
Cost of Ending WIP Inventory and Units Transferred Out
Materials Conversion
Total
Ending WIP inventory:
Equivalent units
540
270
Cost per equivalent unit
$
21.00
$
15.00
4-48
Applying Costs
Assembly Department
Cost of Ending WIP Inventory and Units Transferred Out
Materials Conversion
Total
Ending WIP inventory:
Equivalent units
540
270
Cost per equivalent unit
$
21.00
$
15.00
Cost of Ending WIP inventory
$ 11,340
$
4,050
$ 15,390
4-49
Computing the Cost of Units
Transferred Out
Assembly Department
Cost of Ending WIP Inventory and Units Transferred Out
Materials Conversion
Total
Ending WIP inventory:
Equivalent units
540
270
Cost per equivalent unit
$
21.00
$
15.00
Cost of Ending WIP inventory
$ 11,340
$
4,050
$ 15,390
Units completed and transferred out:
Units transferred
5,400
5,400
4-50
Computing the Cost of Units
Transferred Out
Assembly Department
Cost of Ending WIP Inventory and Units Transferred Out
Materials Conversion
Total
Ending WIP inventory:
Equivalent units
540
270
Cost per equivalent unit
$
21.00
$
15.00
Cost of Ending WIP inventory
$ 11,340
$
4,050
$ 15,390
Units completed and transferred out:
Units transferred
5,400
5,400
Cost per equivalent unit
$
21.00
$
15.00
4-51
Computing the Cost of Units
Transferred Out
Assembly Department
Cost of Ending WIP Inventory and Units Transferred Out
Materials Conversion
Total
Ending WIP inventory:
Equivalent units
540
270
Cost per equivalent unit
$
21.00
$
15.00
Cost of Ending WIP inventory
$ 11,340
$
4,050
$ 15,390
Units completed and transferred out:
Units transferred
5,400
5,400
Cost per equivalent unit
$
21.00
$
15.00
Cost of units transferred out
$ 113,400
$ 81,000
$ 194,400
4-52
Learning Objective 5
Prepare a cost
reconciliation report.
4-53
Reconciling Costs
Assembly Department
Cost Reconciliation
Costs to be accounted for:
Cost of beginning Work in Process Inventory
Costs added to production during the period
Total cost to be accounted for
$
$
10,039
199,751
209,790
4-54
Reconciling Costs
Assembly Department
Cost Reconciliation
Costs to be accounted for:
Cost of beginning Work in Process Inventory
Costs added to production during the period
Total cost to be accounted for
Cost accounted for as follows:
Cost of ending Work in Process Inventory
Cost of units transferred out
Total cost accounted for
$
$
$
$
10,039
199,751
209,790
15,390
194,400
209,790
4-55
Appendix 4A
FIFO Method
PowerPoint Authors:
Jon A. Booker, Ph.D., CPA, CIA
Charles W. Caldwell, D.B.A., CMA
Susan Coomer Galbreath, Ph.D., CPA
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
4-56
FIFO vs. Weighted-Average Method
The FIFO method (generally considered
more accurate that the weighted-average
method) differs from the weighted-average
method in two ways:
1. The computation of equivalent units.
2. The way in which the costs of beginning
inventory are treated.
4-57
Learning Objective 6
Compute the equivalent
units of production using
the FIFO method.
4-58
Equivalent Units – FIFO Method
Let’s revisit the Smith Company example. Here is information
concerning the Assembly Department for the month of
June.
Percent Completed
Units
Work in Process, June 1
300
Units started into production in June
6,000
Units completed and transferred out
of Department A during June
5,400
Work in Process, June 30
900
Materials Conversion
40%
20%
60%
30%
4-59
Equivalent Units – FIFO Method
Step 1: Determine equivalent units needed to complete
beginning Work in Process inventory.
Materials
To complete beginning Work in Process:
Materials: 300 units × (100% - 40%)
Conversion: 300 units × (100% - 20%)
Conversion
180
240
4-60
Equivalent Units – FIFO Method
Step 2: Determine units started and completed during
the period.
Materials
To complete beginning Work in Process:
Materials: 300 units × (100% - 40%)
180
Conversion: 300 units × (100% - 20%)
Units started and completed during June
Conversion
240
5,100
5,100
4-61
Equivalent Units – FIFO Method
Step 3: Add the equivalent units in ending Work in
Process inventory.
Materials
To complete beginning Work in Process:
Materials: 300 units × (100% - 40%)
180
Conversion: 300 units × (100% - 20%)
Units started and completed during June
Conversion
240
5,100
5,100
Ending Work in Process:
Materials: 900 units × 60% complete
Conversion: 900 units × 30% complete
Equivalent units of production
540
270
5,820
5,610
4-62
FIFO Example
Materials
Beginning
Work in Process
300 Units
40% Complete
300 × 60%
6,000 Units Started
5,100 Units Started
and Completed
180 Equivalent Units
5,100 Units Completed
540 Equivalent Units
5,820 Equivalent units
of production
Ending
Work in Process
900 Units
60% Complete
900 × 60%
4-63
FIFO Example
Conversion
Beginning
Work in Process
300 Units
20% Complete
300 × 80%
6,000 Units Started
5,100 Units Started
and Completed
240 Equivalent Units
5,100 Units Completed
270 Equivalent Units
5,610 Equivalent units
of production
Ending
Work in Process
900 Units
30% Complete
900 × 30%
4-64
Equivalent Units: WeightedAverage vs. FIFO
As shown below, the equivalent units in beginning inventory are
subtracted from the equivalent units of production per the
weighted-average method to obtain the equivalent units of
production under the FIFO method.
Equivalent units - weighted-average method
Less equivalent units in beginning inventory:
300 units × 40%
300 units × 20%
Equivalent units - FIFO method
Materials
5,940
Conversion
5,670
120
5,820
60
5,610
4-65
Learning Objective 7
Compute the cost per equivalent
unit using the FIFO method.
4-66
Cost per Equivalent Unit - FIFO
Let’s revisit the Smith Company Assembly Department
for the month of June to prepare our production report.
Beginning Work in Process:
Materials: 40% complete
Conversion: 20% complete
$
$
400 units
6,119
3,920
Production started during June
Production completed during June
6,000 units
5,400 units
Costs added to production in June:
Materials cost
Conversion cost
$ 118,621
$ 81,130
Ending Work in Process:
Materials:
60% complete
Conversion: 30% complete
900 units
4-67
Cost per Equivalent Unit - FIFO
The formula for computing the cost per
equivalent unit under FIFO method is:
Cost per
equivalent =
unit
Cost added during the period
Equivalent units of production
4-68
Cost per Equivalent Unit - FIFO
Total
Cost
Cost added in June
Equivalent units
$ 199,751
Cost per equivalent unit
$118,600 ÷ 5,820
Materials
Conversion
$ 118,621
5,820
$
$ 20.3816
$ 14.4617
81,130
5,610
$81,130 ÷ 5,610
Total cost per equivalent unit = $20.3816 + $14.4617 = $34.8433
4-69
Learning Objective 8
Assign costs to units
using the FIFO method.
4-70
Applying Costs - FIFO
Step 1: Record the equivalent units of production in ending Work
in Process inventory.
Assembly Department
Cost of Ending WIP Inventory
Materials Conversion
Ending WIP inventory:
Equivalent units
540
900 units × 60%
270
900 units × 30%
Total
4-71
Applying Costs - FIFO
Step 2: Record the cost per equivalent unit.
Assembly Department
Cost of Ending WIP Inventory
Materials Conversion
Ending WIP inventory:
Equivalent units
Cost per equivalent unit
540
$ 20.3816
270
$ 14.4617
Total
4-72
Applying Costs - FIFO
Step 3: Compute the cost of ending Work in Process inventory.
Assembly Department
Cost of Ending WIP Inventory
Materials Conversion
Ending WIP inventory:
Equivalent units
Cost per equivalent unit
Cost of Ending WIP inventory
540
$ 20.3816
$ 11,006
540 × $20.3816
270
$ 14.4617
$
3,905
270 × 14.4617
Total
$
14,911
4-73
Cost of Units Transferred Out
Step 1: Record the cost in beginning Work in Process inventory.
Assembly Department
Cost of Units Transferred Out in June
Materials Conversion
Cost of Units Transferred Out:
Cost in beginning WIP inventory
$
6,119
$
3,920
Total
$
10,039
4-74
Cost of Units Transferred Out
Step 2: Compute the cost to complete the units in beginning
Work in Process inventory.
Assembly Department
Cost of Units Transferred Out in June
Materials Conversion
Cost of Units Transferred Out:
Cost in beginning WIP inventory
$
6,119
$
3,920
Cost to complete beginning WIP
Equivalent units to complete
180
240
Cost per equivalent unit
$ 20.3816
$ 14.4617
Cost to complete beginning WIP
$
3,668
$
3,471
Total
$
10,039
7,139
4-75
Cost of Units Transferred Out
Step 3: Compute the cost of units started and completed this
period.
Assembly Department
Cost of Units Transferred Out in June
Materials Conversion
Cost of Units Transferred Out:
Cost in beginning WIP inventory
$
6,119
$
3,920
Cost to complete beginning WIP
Equivalent units to complete
180
240
Cost per equivalent unit
$ 20.3816
$ 14.4617
Cost to complete beginning WIP
$
3,668
$
3,471
Cost of units started and completed:
Units started and completed
5,100
5,100
Cost per equivalent unit
$ 20.3816
$ 14.4617
Cost of units started and completed
$ 103,946
$ 73,755
Total
$
10,039
7,139
177,701
4-76
Cost of Units Transferred Out
Step 4: Compute the total cost of units transferred out.
Assembly Department
Cost of Units Transferred Out in June
Materials Conversion
Cost of Units Transferred Out:
Cost in beginning WIP inventory
$
6,119
$
3,920
Cost to complete beginning WIP
Equivalent units to complete
180
240
Cost per equivalent unit
$ 20.3816
$ 14.4617
Cost to complete beginning WIP
$
3,668
$
3,471
Cost of units started and completed:
Units started and completed
5,100
5,100
Cost per equivalent unit
$ 20.3816
$ 14.4617
Cost of units started and completed
$ 103,946
$ 73,755
Cost of Units Transferred Out
Total
$
10,039
7,139
177,701
$ 194,879
4-77
Learning Objective 9
Prepare a cost
reconciliation report
using the FIFO method.
4-78
Reconciling Costs
Assembly Department
Cost Reconciliation for June
Costs to be accounted for:
Cost of beginning Work in Process Inventory
Costs added to production during the period
Total cost to be accounted for
$
$
10,039
199,751
209,790
4-79
Reconciling Costs
Assembly Department
Cost Reconciliation for June
Costs to be accounted for:
Cost of beginning Work in Process Inventory
Costs added to production during the period
Total cost to be accounted for
Cost accounted for as follows:
Cost of ending Work in Process Inventory
Cost of units transferred out
Total cost accounted for
$
$
$
$
10,039
199,751
209,790
14,911
194,879
209,790
4-80
A Comparison of Costing Methods
In a lean production environment, FIFO and
weighted-average methods yield similar
unit costs.
When considering cost control, FIFO is
superior to weighted-average because it
does not mix costs of the current period with
costs of the prior period.
4-81
End of Chapter 4