PROCESS COSTING I

Horngren’s Cost Accounting 17/e, Datar/Rajan

 LEARNING OBJECTIVES

1 Identify the situations in which process-costing systems are

appropriate
2 Understand the basic concepts of process costing and compute
average unit costs
3 Describe the five steps in process costing and calculate equivalent
units
4 Use the weighted-average method and the first-in, first-out (FIFO)
method of process costing
5 Apply process-costing methods to situations with transferred-in costs
6 Understand the need for hybridcosting systems such as operation
costing.

Horngren’s Cost Accounting 17/e, Datar/Rajan

 BEFORE EXAMINING PROCESS COSTING IN DETAIL, LET’S BRIEFLY
REVIEW THE DISTINCTION BETWEEN JOB COSTING AND PROCESS
COSTING EXPLAINED IN CHAPTER 4. JOB-COSTING AND PROCESS-
COSTING SYSTEMS ARE BEST VIEWED AS ENDS OF A CONTINUM:
JOB-COSTING PROCESS-COSTING
SYSTEM SYSTEM

Distinct, identifiable units of a Masses of identical or similar units

product or service (for example, of a product or service (for example,
custom-made machines and houses) food or chemicals)

Horngren’s Cost Accounting 17/e, Datar/Rajan

 WHAT IS THIS TOPIC ABOUT?
A PROCESS COST SYSTEM
In a process-costing
system, the unit cost of
a product or service is
obtained by assigning
total
costs to many identical A.
or similar units of output.
IN A MANUFACTURING PROCESS-
COSTING SETTING,
each unit receives the same or UNIT COST
similar amounts of direct
material costs, direct Unit cost equals total costs

C. B.
manufacturing labor divided by the number
costs, and indirect of units of output from the
manufacturing costs production process.
(manufacturing overhead).
Horngren’s Cost Accounting 17/e, Datar/Rajan
 CONSIDER THE FOLLOWING EXAMPLE :

Pacific Electronics manufactures a cell phone, model SG-40.

The phones are assembled in the assembly department. Upon
completion, units are transferred to the testing department. All units of
SG-40 are identical. The process-costing system for SG-40 in the
assembly department has a single direct-cost category—direct
materials—and a single indirect-cost category—conversion costs.
Conversion costs are all manufacturing costs other than
direct material costs, including manufacturing labor, energy, plant
depreciation, and so on. Direct materials, such as a phone’s processor,
image sensors, and microphone, are added at the beginning of the
assembly process. Conversion costs are added evenly during assembly.

Horngren’s Cost Accounting 17/e, Datar/Rajan

 THE FOLLOWING GRAPHIC REPRRESENTS THESE
Conversion costs FACTS : .
added evenly
during process Transfer
Assembly Testing
Department Department

Direct materials
added at beginning
of process

Horngren’s Cost Accounting 17/e, Datar/Rajan

 TWO COST CLASSIFICATIONS

Process-costing systems separate costs into cost

categories according to when costs are introduced
into the process. Often, as in our Pacific Electronics
example, only two cost classifications—direct
materials and conversion costs—are necessary to
assign costs to products. Why only two?

Because :
all direct materials are added to the process at one
time and all conversion costs generally are added to
the process evenly through time. Sometimes the
situation is different.

Horngren’s Cost Accounting 17/e, Datar/Rajan

 1. If two different direct materials— 2. If manufacturing labor costs are added to the process
such as the processor and digital camera— at a different time compared to other conversion costs,
are added to the process at different times, two an additional cost category—
different direct materials categories would be direct manufacturing labor costs—
needed to assign these costs to products. would be needed to assign these costs to products.

IMPORTANT …

Horngren’s Cost Accounting 17/e, Datar/Rajan

 WE ILLUSTRATE PROCESS COSTING USING THREE CASES OF INCREASING
COMPLEXITY :

CASE 1 CASE 2 CASE 3

Process costing with zero Process costing with zero beginning Process costing with some
beginning and zero ending work-in- work-in-process inventory and some beginning and some ending work-
process inventory of SG-40 (all ending work-in-process inventory of in-process inventory of SG-40.
units are started and fully SG-40. (That is, some units of SG- This case adds more complexity
completed within the accounting 40 started during the accounting and illustrates the effects the
period). period are incomplete at the end of weighted average and first-in,
This case presents the most basic the period.) first-out (FIFO) methods have on
concepts of process costing and This case introduces the five steps the cost of units completed and
illustrates the averaging of of process costing and the concept the cost of work-in-process
costs. of equivalent units. inventory.

Horngren’s Cost Accounting 17/e, Datar/Rajan

 CASE 01
PROCESS COSTING WITH ZERO
BEGINNING
OR ENDING WORK-IN-PROCESS
INVENTORY .

Horngren’s Cost Accounting 17/e, Datar/Rajan

 On January 1, 2020, there was no beginning inventory of SG-40 units in the assembly
department.
During the month of January, Pacific Electronics started, completely assembled, and transferred
400 units to the testing department.
Data for the assembly department for January 2020 follow:

Physical Units for January 2020

Work in process, beginning inventory (January 1) 0 units
Started during January 400 units
Completed and transferred out during January 400 units
Work in process, ending inventory (January 31) 0 units

Physical units refer to the number of output units, whether complete or incomplete.
In January 2020, all 400 physical units started were completed.

Total Costs for January 2020

Direct materials costs added during January $32,000
Conversion costs added during January 24,000
Total assembly department costs added during January $56,000

Horngren’s Cost Accounting 17/e, Datar/Rajan

 Pacific Electronics records direct materials costs and conversion costs in the
assembly department as these costs are incurred.
The cost per unit equals total costs incurred in a given accounting period
divided by total units produced in that period.
So, the assembly department cost of SG-40 is $56,000 : 400 units = $140 per
unit:

Direct materials cost per unit ($32,000 : 400 units) $ 80

Conversion costs per unit ($24,000 : 400 units) $ 60
Assembly department cost per unit $140

Horngren’s Cost Accounting 17/e, Datar/Rajan

 CASE 02
PROCESS COSTING WITH ZERO
BEGINNING
AND SOME ENDING WORK-IN-
PROCESS INVENTORY
.

Horngren’s Cost Accounting 17/e, Datar/Rajan

 In February 2020, Pacific Electronics places another 400 units of SG-40 into production.
Recall there is no beginning inventory of partially completed units in the assembly department on
February 1. Of the 400 units started in February, only 175 units are completed and transferred
to the testing department. Data for the assembly department for February 2020 follow:

Horngren’s Cost Accounting 17/e, Datar/Rajan

 The 225 partially assembled units as of February 29 2020, are fully processed for
direct materials because all direct materials in the assembly department are added
at the beginning of the assembly process. Conversion costs, however, are added
evenly during assembly. An assembly department supervisor estimates that the
partially assembled units are, on average, 60% complete with respect to conversion
costs. The accuracy of the completion estimate depends on the care, skill, and
experience of the estimator and the nature of the conversion process. Estimating
degree of completion is usually easier for direct materials costs than for conversion
costs because the quantity of direct materials needed for a completed unit and the
quantity of direct materials in a partially completed unit can be measured more
accurately. In contrast, the conversion sequence usually consists of a number of
operations, each for a specified period of time, at various steps in the production
process. For example, consider the conventional tanning process for converting hide
to leather. Obtaining 250–300 kg of leather requires putting one metric ton of raw
hide through as many as 15 steps: from soaking, liming, and pickling to tanning,
dyeing, and fatliquoring, the step in which oils are introduced into the skin before
the leather is dried.
The Cost
Horngren’s degree
Accountingof completion for conversion costs depends on the proportion of total
17/e, Datar/Rajan
 IN
GREATER DETAIL NEXT AS PART OF THE SET OF FIVE STEPS REQUIRED TO CALCULATE (1) THE COST OF
FULLY ASSEMBLED
UNITS IN FEBRUARY 2020 AND (2) THE COST OF PARTIALLY ASSEMBLED UNITS STILL IN PROCESS AT
THE
END OF THAT MONTH, FOR PACIFIC ELECTRONICS. THE FIVE STEPS OF PROCESS COSTING ARE SHOWN
BELOW:

STEP 1 STEP 2 STEP 3 STEP 4 STEP 5

Assign total costs to

Summarize the flow Compute output in units completed and
Summarize total Compute cost per
of physical units of terms of equivalent to units in ending
costs to account for equivalent unit
output units work-in-process
inventory

Horngren’s Cost Accounting 17/e, Datar/Rajan

 EXHIBIT 18-1 SUMMARIZE THE FLOW OF PHYSICAL UNITS AND COMPUTE OUTPUT IN
EQUIVALENT UNITS FOR THE ASSEMBLY DEPARTMENT FOR FEBRUARY
2020

Horngren’s Cost Accounting 17/e, Datar/Rajan

 EXHIBIT 18-2 SUMMARIZE TOTAL COSTS TO ACCOUNT FOR, COMPUTE COST PER
EQUIVALENT UNIT, AND ASSIGN COSTS TO UNITS COMPLETED AND
UNITS IN ENDING WORK-IN-PROCESS INVENTORY FOR THE ASSEMBLY
DEPARTMENT FOR FEBRUARY 2020

Horngren’s Cost Accounting 17/e, Datar/Rajan

 Step 5 assigns total direct materials and conversion costs to units completed and
transferred
out and to units still in process at the end of February 2020. As Exhibit 18-2 shows, this is
done for each input by multiplying the equivalent output units by the cost per equivalent unit.
For example, total costs (direct materials and conversion costs assigned to the 225 physical
units in ending work-in-process inventory) are as follows:
Direct material costs of 225 equivalent units (calculated in Step 2) x
$80 cost per equivalent unit of direct materials (calculated in Step 4) $18,000
Conversion costs of 135 equivalent units (calculated in Step 2) x
$60 cost per equivalent unit of conversion costs (calculated in Step 4) 8,100
Total cost of ending work-in-process inventory $26,100

Total costs to account for in Step 3 ($50,600) equal total costs accounted for in
Step 5.

Horngren’s Cost Accounting 17/e, Datar/Rajan

 Journal Entries
Journal entries in process-costing systems are similar to entries made in job-costing systems with
respect to direct materials and conversion costs. The main difference is that in process costing
there is one Work in Process account for each process. In our example, there are two accounts:
(1) Work in Process—Assembly and (2) Work in Process—Testing. Pacific Electronics purchases
direct materials as needed, with materials being delivered directly to the assembly department.
Using amounts from Exhibit 18-2, summary journal entries for February are as follows:

1. Work in Process—Assembly 32,000

Accounts Payable Control 32,000
To record direct materials purchased and used in production
in February.

2. Work in Process—Assembly 18,600

Various accounts such as Wages Payable Control
and Accumulated Depreciation 18,600
To record conversion costs for February; examples include energy, manufacturing
supplies, all manufacturing labor, and plant depreciation.

3. Work in Process—Testing 24,500

Work in Process—Assembly 24,500
To record cost of goods completed and transferred from assembly to testing in February.
Horngren’s Cost Accounting 17/e, Datar/Rajan
 EXHIBIT 18-3 FLOW OF COSTS IN A PROCESS-COSTING SYSTEM FOR THE
ASSEMBLY DEPARTMENT
FOR FEBRUARY 2020

Horngren’s Cost Accounting 17/e, Datar/Rajan

 CASE 03
PROCESS COSTING WITH SOME
BEGINNING
AND SOME ENDING WORK-IN-
PROCESS INVENTORY

Horngren’s Cost Accounting 17/e, Datar/Rajan

 At the beginning of March 2020, Pacific Electronics had 225 partially assembled SG-40 units in the
assembly department. It started production of another 275 units in March. The data for the assembly
department for March follow:

Horngren’s Cost Accounting 17/e, Datar/Rajan

 Pacific Electronics has incomplete units in both beginning work-in-process inventory and ending
work-in-process inventory for March 2020. We use the five steps described earlier to assign costs
to
(1) the cost of units completed and transferred out and
(2) (2) the cost of ending working-process inventory. To do so, we first need to choose an
inventory-valuation method.

We describe the five-step approach for two key methods—the weighted-average method and the
first-in, first-out method. The different valuation methods generally produce different costs for
units completed and for ending work-in-process inventory

Horngren’s Cost Accounting 17/e, Datar/Rajan

 Weighted-Average Method
STEP SUMMARIZE THE FLOW OF
01 PHYSICAL UNITS OF
STEP OUTPUT
COMPUTE OUTPUT IN
02 TERMS OF EQUIVALENT
UNITS
STEP
SUMMARIZE TOTAL COSTS
03 TO ACCOUNT FOR
STEP
Compute Cost per Equivalent
04 Unit
ASSIGN COSTS TO UNITS
Step 05 COMPLETED AND TO UNITS
IN ENDING WORK-IN-
Horngren’s Cost Accounting 17/e, Datar/Rajan PROCESS INVENTORY
 EXHIBIT 18-4 SUMMARIZE THE FLOW OF PHYSICAL UNITS AND COMPUTE
OUTPUT IN EQUIVALENT UNITS USING THE WEIGHTED-
AVERAGE METHOD FOR THE ASSEMBLY DEPARTMENT FOR
MARCH 2020

Horngren’s Cost Accounting 17/e, Datar/Rajan

 EXHIBIT 18-5 SUMMARIZE TOTAL COSTS TO ACCOUNT FOR, COMPUTE COST PER EQUIVALENT
UNIT, AND ASSIGN COSTS TO UNITS COMPLETED AND TO UNITS IN ENDING WORK-
IN-PROCESS INVENTORY USING THE WEIGHTED-AVERAGE METHOD FOR THE
ASSEMBLY DEPARTMENT FOR MARCH 2020

Horngren’s Cost Accounting 17/e, Datar/Rajan

Horngren’s Cost Accounting 17/e, Datar/Rajan