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19. Process: Cost systems

Learning objectives
After studying this chapter, you should be able to:

• Describe the types of operations that require a process cost system.

• Distinguish between process and job costing systems.

• Discuss the concept of equivalent units in a process cost system.

• Compute equivalent units of production and unit costs under the average cost procedure.

• Prepare a production cost report for a process cost system and discuss its relationship to the Work in Process
Inventory account.

• Distinguish between normal and abnormal spoilage.

• Compute equivalent units of production and unit costs under the first-in first-out (FIFO) system (Appendix
19-A).

• Discuss how joint costs are allocated to joint products (Appendix 19-B).

This chapter continues the discussion of cost accumulation systems. In Chapter 18, we explained and illustrated
job costing. The job cost system (job costing) accumulates costs incurred to produce a product according to
individual jobs. For example, construction companies use job costing to keep track of the costs of each construction
job.

This chapter discusses another cost accumulation system, process costing. The chapter begins with a discussion
of the nature of a process cost system. We review the similarities and differences between job costing and process
costing. We also present an extended illustration of process costing that includes a discussion of equivalent units of
production and the production cost report. In the chapter appendixes, we discuss and illustrate FIFO process
costing and the allocation of joint product costs.

Nature of a process cost system

Many businesses produce large quantities of a single product or similar products. Pepsi-Cola makes soft drinks,
Exxon Mobil produces oil, and Kellogg Company produces breakfast cereals on a continuous basis over long
periods. For these kinds of products, companies do not have separate jobs. Instead, production is an ongoing
process.

A process cost system (process costing) accumulates costs incurred to produce a product according to the
processes or departments a product goes through on its way to completion. Companies making paint, gasoline,
steel, rubber, plastic, and similar products using process costing. In these types of operations, accountants must
accumulate costs for each process or department involved in making the product. Accountants compute the cost per
unit by first accumulating costs for the entire period (usually a month) for each process or department. Second,

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19. Process: Cost systems

they divide the accumulated costs by the number of units produced (tons, pounds, gallons, or feet) in that process
or department.

In "A broader perspective: Producing cans of Coca-Cola", we describe production in bottling and canning plants
that use a process cost system. Job costing and process costing have important similarities:

• Both job and process cost systems have the same goal: to determine the cost of products.

• Both job and process cost systems have the same cost flows. Accountants record production in separate
accounts for materials inventory, labor, and overhead. Then, they transfer the costs to a Work in Process
Inventory account.

• Both job and process cost systems use predetermined overhead rates (defined in Chapter 18) to apply
overhead.

Job costing and process costing systems also have their significant differences:

• Types of products produced. Companies that use job costing work on many different jobs with different
production requirements during each period. Companies that use process costing produce a single product,
either on a continuous basis or for long periods. All the products that the company produces under process
costing are the same.

• Cost accumulation procedures. Job costing accumulates costs by individual jobs. Process costing
accumulates costs by process or department.

• Work in Process Inventory accounts. Job cost systems have one Work in Process Inventory account for each
job. Process cost systems have a Work in Process Inventory account for each department or process.

Exhibit 1 shows the cost flows in a process cost system that processes the products in a specified sequential
order. That is, the production and processing of products begin in Department A. From Department A, products go
to Department B. Department B inputs direct materials and further processes the products. Then Department B
transfers the products to Finished Goods Inventory. For illustration purposes, we assume that all the process cost
systems in this chapter are sequential. There are many production flow combinations; Exhibit 2 presents three
possible production flow combinations.

Process costing illustration

Assume that Jax Company manufactures and sells a chemical product used to clean kitchen counters and sinks.
The company processes the product in two departments. Department A crushes powders and blends the basic
materials. Department B packages the product and transfers it to finished goods. Exhibit 2 shows this
manufacturing process.

The June production and cost data for Jax Company are:
Department A Department B
Beginning inventory -0- -0-
Units started, completed, and transferred 11,000 9,000
Units on hand June 30, partially completed -0- 2,000
Direct materials $16,500 $1,100
Direct labor 2,500 2,880
Actual overhead 7,500 8,600
Applied overhead 7,400 8,880

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Exhibit 1: Cost flows in a process cost system

(Jax's accountant applies manufacturing overhead in Departments A and B based on the machine-hours used in
production.) From these data, we can construct and summarize the Work in Process Inventory—Department A
account below.
Work in process inventory – A
Department
Direct materials 16,500 Transferred to department 26,400
B:
11,000 unites @ $2.40
Direct labor 2,500
Applied overhead 7,400
Balance -0-

Department A completed all the units it started in June and transferred them to Department B. So all the costs
assigned to these units were transferred to Department B. Jax's accountant computed the unit costs in Department
A by dividing the USD 26,400 total costs by the 11,000 units completed and transferred. The result is USD 2.40, the
average unit cost of 11,000 units.

Computations are seldom this simple; one complication is partially completed inventories. Consider Department
B, for example. Before Department B transfers the cost of completed units, its Work in Process Inventory account
for June is as follows:
Work in process inventory – Department B
Transferred in from department A 26,400
Costs added in Dept. B:
Direct materials 1,100
Direct labor 2,880
Applied overhead 8,880
Balance 39,260

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19. Process: Cost systems

Exhibit 2: Possible production flow combinations

A broader perspective:

Producing cans of Coca-Cola®

How was the Diet Coke® I just finished drinking produced? A Coca-Cola bottling plant purchased
cola syrup or a concentrate from The Coca-Cola Company, combined it with carbonated water, put
it in cans, and sealed the cans. (Although these plants are usually called bottling plants, they also
produce cans of Coke®.)

In a bottling plant, the first process combines the syrup or concentrate with carbonated water to
make cola. In a second process, empty cans are rinsed and inspected. A third process combines
these two materials by pouring the cola into the cans. Next, tops are placed on the cans. Finally, the
cans are combined into packages. This completes the work in process stage.

The product enters finished goods inventory when it is sent to the warehouse. The product
becomes cost of goods sold to the bottling plants when it is shipped to distributors or retail outlets.

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Source: Based on the authors' research and documents provided by The Coca-Cola Company. Coca-
Cola, Diet Coke, and Coke are registered trademarks of The Coca-Cola Company.

Recall that direct materials, direct labor, and applied overhead are product costs; that is, the costs attach to the
product. Thus, Transferred in from Department A in the T-account represents the direct materials, direct labor, and
applied overhead costs assigned to products in Department A. These costs have followed the physical units to
Department B.

Now, Jax's accountant must divide the USD 39,260 total costs charged to Department B in June between the
units transferred out and those remaining on hand in the department. The accountant cannot divide USD 39,260
by 11,000 units to get an average unit cost because the 11,000 units are not alike. Department B has 9,000 finished
units and has 2,000 partially finished units. To solve this problem, the accountant uses the concept of equivalent
units of production, which we discuss next.

Essentially, the concept of equivalent units involves expressing a given number of partially completed units as
a smaller number of fully completed units. For example, if we bring 1,000 units to a 40 per cent state of completion,
this is equivalent to 400 units that are 100 per cent complete. Accountants base this concept on the supposition
that a company must incur approximately the same amount of costs to bring 1,000 units to a 40 per cent level of
completion as it would to complete 400 units.

On the next page look at Exhibit 3, a diagram of the concept of equivalent units. As you examine the diagram,
think of the amount of water in the glasses as costs that the company has already incurred.

The beginning step in computing Department B's equivalent units for Jax Company is determining the stage of
completion of the 2,000 unfinished units. These units are 100 per cent complete as to transferred-in costs; if
they were not, Department A would not have transferred them to Department B. In Department B, however, the
units may be in different stages of completion regarding the materials, labor, and overhead costs. Assume that
Department B adds all materials at the beginning of the production process. Then both ending inventory and units
transferred out would be 100 per cent complete as to materials. Therefore, equivalent production for materials
would be 11,000 units.

Accountants often assume that units are at the same stage of completion for both labor and overhead.
Accountants call the combined labor and overhead costs conversion costs. Conversion costs are those costs
incurred to convert raw materials into the final product.

Let us assume that, on average, the 2,000 units in ending inventory are 40 per cent complete as to conversion
costs. This means that Department B transferred out 9,000 units fully completed and brought 2,000 units to a 40
per cent completion state. Department B now has an equivalent of 800 fully completed units remaining in
inventory (800 = 2,000 X 40 per cent). The equivalent units for labor and overhead would therefore be 9,800
units.

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19. Process: Cost systems

Exhibit 3: The concept of equivalent units

The formula for equivalent units for each cost element (transferred-in, materials, and conversion) is:

Equivalent units = Units completed + (Units in ending inventory Xper cent complete)

When we know the equivalent units of production, we can compute unit costs for transferred-in, materials, and
conversion elements. The average unit cost formulas for each cost element are:

Total transferred costs

Unit cost for transferred=
Equivalent unitsfor transferred costs

Total materials costs

Unit cost for materials=
Equivalent unitsfor conversion costs

Total conversion costs

Unit cost for conversion=
Equivalent units for conversion costs

Know we can compute unit costs for each element in Department B as follows:
Transferred-in Materials Conversion Total
Costs to be accounted for:
Charged to Department B $26,000 $1,100 $11,760* $39,260
Equivalent units 11,000 11,000 9,800†
Unit costs $ 2.40 $ 0.10 $ 1.20 $ 4.70
*Conversion costs consist of direct labor + overhead ($2,880 + $8,880).
†Units transferred out (9,000) + equivalent units in ending inventory (800).

We can use the USD 3.70 computed unit costs to divide Department B's USD 39,260 June costs between the
units completed and transferred out and the units remaining in the department's ending inventory. We do this in
the following table:
Transferred-in Materials Conversion Total
(@ $2.40) (@ $0.10) (@ $1.20)
Costs accounted for:
Units completed and $900 $10,800 $33,300
transferred out $21,600
(9,000 units)
Units remaining in ending
inventory 4,800 200 960* 5,960
(2,000 units)
Costs accounted for $26,400 $1,100 $11,760 $39,260
*Equivalent units = 800 units

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The USD 33,300 total costs transferred out of Department B consist of USD 21,600 transferred in from
Department A (9,000 X USD 2.40), USD 900 of materials costs (9,000 X USD 0.10), and USD 10,800 of
conversion costs (9,000 X USD 1.20), or a total cost of USD 3.70 per unit. The 2,000 units of ending inventory in
Department B are fully complete as to costs transferred in from Department A and materials and 40 per cent
complete as to conversion. We calculate the ending inventory cost as follows:
Costs from Department A (2,000 x $2.40) $4,500
Costs added by Department B:
Materials (2,000 x $0.10) $200
Conversion (800 equivalent units x $1.20) 960 1160
Total cost of ending inventory $5,960

Jax carries units transferred out of Department B in finished goods inventory at a cost of USD 3.70 each until
they are sold. Then, Jax charges the cost of units sold to Cost of Goods Sold.

An ethical perspective:
Rynco Scientific Corporation

Rynco Scientific Corporation was a manufacturer of contact lenses that the Securities and Exchange
Commission (SEC) investigated concerning the way it computed equivalent units of production.
According to the SEC, Rynco made errors in calculating the equivalent units of production that
materially overstated its ending inventory, and understated its losses. As a result of the SEC's
investigation, Rynco agreed to hire an accounting firm to conduct a thorough study of its financial
statements for a five-year period, and it agreed to restate its financial statements to conform to
generally accepted accounting principles.

We have discussed how to determine the costs of each cost element placed in production, transferred to finished
goods inventory, and charged to cost of goods sold. Now let us look at the summary of the journal entries for these
activities for the month of June.
1. Work in process inventory – Department A (+A) 16,500
Work in process inventory – Department B (+A) 1,100
Materials inventory (-A) 17,600
To record materials placed in production in June.

2. Work in process inventory – Department A (+A) 2,500

Work in process inventory – Department B (+A) 2,880
Payroll summary (+L) 5,380
To assign labor costs to departments.

3. Work in process inventory – Department A (+A) 7,400

Work in process inventory – Department B (+A) 8,880
Overhead (or manufacturing overhead) (+SE) 16,280
To apply overhead to production.

4. Work in process inventory – Department B (+A) 26,400

Work in process inventory – Department A (-A) 26,400
To record transfer of goods from Department A to Department
B.

5. Overhead (of Manufacturing Overhead) (-SE) 16,100

Various accounts – Cash, Accounts payable, accruals, and
accumulated depreciation (varies) 16,100
To record actual overhead costs incurred in June.

6. Finished goods inventory (+A) 33,300

Work in process inventory – Department B (-A) 33,300

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19. Process: Cost systems

To record transfer of completed goods from Department B to

finished goods.

If Jax Company sold 6,000 of these completed units in June at USD 10 per unit on account, it would make the
following entries:
7. Accounts receivable (+A) 60,000
Sales (+SE) 60,000
To record sales on account.

8. Cost of goods sold (-SE) 22,200

Finished goods inventory (-A) 22,200
To record cost of goods sold in June, 6,000 units
@$3.70.

The key document in a process costing system is the production cost report. A production cost report shows
both the flow of units and the flow of costs through a processing center. It also shows how accountants divide these
costs between the cost of units completed and transferred out and the cost of units still in the processing center's
ending inventory. This report makes the equivalent unit and unit cost computations easier.

To illustrate the preparation of a production cost report with partially completed beginning and ending
inventories, assume the following June 2011 data for Department 3 of a different company, Storey Company:
Units
Units in beginning inventory, 6,000
complete as to materials, 60%
complete as to conversion costs
Units transferred in from Department 18,000
2
Units completed and transferred out 16,000
Units in ending inventory, completed 8,000
as to materials, 50% complete as to
conversion costs

Costs
Cost of beginning inventory:
Costs transferred in from $12,000
Department 2 in May
Materials added in May in 6,000
Department 3
Conversion costs (labor and 3,000 $21,000
overhead)
Costs transferred in from Department 37,200
2 in June
Costs added in Department 3 in
June:
Materials $18,480
Conversion (equal amounts of labor 36,480
and overhead) 18,000
Total costs in beginning inventory $94,680
and placed in production in
Department 3 in June

The preparation of the production cost report includes the following four steps:

• Trace the physical flow of the units through the production department.

• Convert actual units to equivalent units.

• Compute unit costs for each cost element.

• Distribute the total cost between the units completed and transferred out and the units remaining in the
ending inventory.

Using the June data, Storey developed the production cost report for Department 3 shown in Exhibit 5.

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The first step in the preparation of a production cost report is to trace the physical flow of actual units in and out
of Department 3. The units section in Exhibit 5 shows that Department 3 had 6,000 units in the June beginning
inventory. Department 3 also had 18,000 units transferred in from Department 2. This makes a total of 24,000
units for which Department 3 must account.

Of these 24,000 units, Department 3 completed and transferred out 16,000 units (either to the next processing
department or to finished goods). At the end of the month, Department 3 had 8,000 partially completed units.
These 8,000 units are the June ending inventory. Now we are ready for the second step in the preparation of the
production cost report—to convert actual units to equivalent units.

Storey Company's cost of production report uses the average cost procedure. Under the average cost
procedure, the number of equivalent units for each cost element equals the number of units transferred out plus
the number of equivalent units of that cost element in the ending inventory. The average cost procedure does not
consider the number of units in the beginning inventory and the degree of completion of the beginning inventory.
Alternatively, Storey could use First-in, First-out (FIFO) or Last-in, First-out (LIFO). We use the average cost
procedure in this chapter because it is simpler and commonly used in practice.

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19. Process: Cost systems

Storey Company
Production Cost Department
Report - 3
For the month of Equivalent
June 2011 units
Units Actual units Transferred- Materials Conversion
in
Units in beginning 6,000
inventory
Units transferred in 18,000
from Department 2
Units to be accounted 24,000
for
Units completed and 16,000 16,000 16,000 16,000
transferred out
Units in ending 8,000 8,000 8,000 4,000
inventory*
Units accounted for 24,000 24,000 24,000 20,000

Costs Transferred- Materials Conversion Total

in
Costs to be accounted
for:
Costs in beginning $12,000 $6,000 $3,000 $21,000
inventory
Costs transferred in 37,200 37,200
from Department 2 in
June
Costs added in 18,480 18,000 36,480
Department 3
Costs to be accounted $49,200 $24,480 $21,000 $94,680
for
Equivalent units (from 24,000 24,000 20,000
above)
Unit cost (per $2.05 $1.02 $1.05 $4.12
equivalent unit)†
Costs accounted for:
Units completed and $32,800 $16,320 $16,800 $65,920
transferred out (16,000
units)
Units remaining in 16,400 8,160 4,200 28,760
ending inventory
(8,000 units)*
Costs accounted for $49,200 $24,480 $21,000 $94,680
*Inventory is complete as to materials added, 50% complete as to conversion.
† Unit cost equals costs to be accounted to divided for divided by equivalent units.

Exhibit 4: Production cost report

Storey's units in the ending inventory are fully complete as to costs transferred in and materials cost. Therefore,
the number of equivalent units for each of these cost elements is 24,000 (16,000 units completed and transferred
out + [8,000 units in the ending inventory X 100 per cent complete for transferred-in costs and materials costs]).
The 8,000 units remaining in ending inventory are 50 per cent complete as to conversion. Therefore, there are
20,000 equivalent units with regards to conversion—16,000 units transferred out plus 8,000 units in ending
inventory that were 50 per cent complete.

Once a company has computed its equivalent units, it must calculate the unit costs. This is the third step in
preparing the production cost report. Each cost element of production—costs transferred in, materials, and
conversion—has accumulated costs. Notice in Exhibit 4 that for each cost element, we total the costs of beginning
inventory and costs of the current month. We refer to the total costs charged to a department as costs to be
accounted for. These costs must either be transferred out or appear in the ending inventory of Department 3.

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To determine the cost per equivalent unit for each cost element, divide the total cost for each cost element by the
equivalent units of production related to that cost element. (Since we totaled all costs for each cost element before
the division, we can average the computed unit costs across the current and prior period.) Exhibit 4 shows the
average per unit costs for June as transferred-in costs, USD 2.05; materials costs, USD 1.02; and conversion costs,
USD 1.05. In monitoring these costs closely for cost control purposes, management watches for extreme
fluctuations from one month to the next.

The last step in preparing the production cost report is to allocate costs between the units completed and
transferred out and the units remaining in ending inventory. The units transferred out were fully complete as to all
elements of production. Therefore, we can multiply the 16,000 units by USD 4.12, the total cost per unit. The result,
USD 65,920, is the amount Storey assigns to the next department as cost transferred in or to finished goods as the
cost of completed current period production. We now compute the cost of ending inventory as follows:
8,000 equivalent units transferred in @ $2.05
8,000 equivalent units of materials costs @ $1.02
4,000 equivalent units of conversion costs @ $1.05
Total cost of ending inventory

The sum of the ending inventory cost and the cost of the units transferred out must equal the total costs to be
accounted for. This built-in check determines whether the company has properly followed the procedures of cost
allocation. As shown in the production cost report, Department 3 adds the USD 65,920 costs transferred out to the
USD 28,760 ending inventory cost. The total equals the USD 94,680 for which Department 3 must account.

Some companies replace the production cost report with three schedules. The first schedule is the schedule of
equivalent production. This schedule computes the equivalent units of production for the period for transferred-in,
materials, and conversion costs. The second schedule is the unit cost analysis schedule. This schedule sums all the
costs charged to the Work in Process Inventory account of each production process department. Then it calculates
the cost per equivalent unit for transferred-in, materials, and conversion costs. The third schedule is the cost
summary schedule. This schedule uses the results of the preceding two schedules to distribute the total costs
accumulated during the period among all the units of output. Companies generally show these three schedules in a
process cost analysis report.

Companies that use a process cost system may use the first-in, first-out (FIFO) method instead of the
average cost procedure. Generally, under FIFO, the equivalent number of units for each cost element consists of:

• Work needed to complete the units in beginning inventory.

• Work done on units started and completed during the period.

• Work done on partially completed units in ending inventory.

Appendix 19-A, at the end of this chapter, illustrates this method.

Now that you have studied both job costing in Chapter 18 and process costing in this chapter, you can appreciate
why manufacturing companies must accurately account for product unit costs. Without accurate cost accounting
information, a manufacturing company cannot determine the cost of its products for managerial decision making
or prepare accurate financial statements.

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19. Process: Cost systems

Process costing in service organizations

Service organizations that provide similar services to a variety of customers are potential users of process
costing. For example, a clinic dispensing flu shots, a delicatessen selling only pastrami sandwiches, and a photo
shop that processes pictures could use process costing. In manufacturing, the difficult task is to match period costs
with the units produced that period, which is why companies compute equivalent units of production. (And that is
what most people find difficult about process costing.)

Generally, service companies complete the service by the end of the period and have no work in process at the
end of the period. Nurses do not leave for home halfway through giving a flu shot, and the delicatessen does not
partially serve a sandwich one month and complete it the next. Consequently, there is no need to compute
equivalent units, which simplifies process costing.

Note that some service companies do have partially completed work at the end of the period. Certain types of dry
cleaning and photo processing may still be in process at the end of a period. You could apply the methods described
in this chapter for manufacturing to those service companies. For materials, you could substitute any significant
supplies, and for conversion costs, service labor and overhead.

Spoilage
If you have ever tried to make something that did not work out, you know the concept of spoilage. Spoilage
refers to the loss of goods during production. For example, suppose some of the cans are dented during the canning
of tuna fish. Accountants would treat the cost of the dented cans of tuna fish as spoilage.

Accountants treat spoilage either as normal spoilage or abnormal spoilage. Normal spoilage occurs in the
normal production process. Accountants generally assign normal spoilage costs to the good units produced.
According to one method found in practice, accountants divide the total cost of production by the good units
produced.

For example, suppose the total cost of producing tuna fish for one day is USD 100,000. The company produced
220,000 cans of tuna fish, but 20,000 cans of tuna fish did not meet quality inspection requirements.
Consequently, these 20,000 units were considered to be spoiled in the normal production process. One way
accountants deal with the cost of such normal spoilage is to compute the cost per good unit by dividing total
production costs by the number of good cans of tuna fish produced. That is:

USD 100,000
Cost per good unit=
200,000 good units producted

= USD 0.50 per good unit produced

Abnormal spoilage refers to spoilage that exceeds the amount expected under normal operating conditions.
For example, if denting the tuna fish cans is unusual, accountants would treat the cost of those dented cans of tuna
fish as abnormal spoilage. Whereas normal spoilage costs are assigned to good products, abnormal spoilage costs
are typically expensed. Thus, accountants treat normal spoilage as a product cost and abnormal spoilage as a period
cost.

Advocates of total quality management may prefer to classify all spoilage as abnormal. Normal spoilage costs are
buried in the costs of the good products. Unless management personnel ask for a special analysis of spoilage costs,

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they will not know whether the spoilage costs are a small per cent or a large per cent of product costs. For example,
management could see a report on tuna fish production costs stating the cost is USD 0.50 per can, but they do not
know how much of the USD 0.50 was the cost of spoilage.

We recommend that accountants report spoilage costs to management, whether normal spoilage or abnormal
spoilage, so management can make informed decisions to reduce spoilage.
Understanding the learning objectives
• Process cost systems are used for businesses that produce products on a continuous basis over long periods.

• Paint, paper, chemicals, gasoline, beverages, and food products should be accounted for under a process
cost system.

• Types of products produced under each system: Companies that use job costing work on many different
jobs with different production requirements during each period. Companies that use process costing produce a
single product, either on a continuous basis or for long periods.

• Cost accumulation procedures used under each system: Job costing accumulates costs by individual jobs.
Process costing accumulates costs by process or department.

• Work in Process accounts: Job cost systems have a Work in Process Inventory account for each job. Process
cost systems have a Work in Process Inventory account for each department or process.

• Whenever partially completed inventories are present, the number of equivalent units of production must
be computed. Basically, the concept of equivalent units involves expressing a given number of partially
completed units as a smaller number of fully completed units.

• As a simple example of equivalent units, two apples that are half eaten are equivalent to one whole apple
eaten. In manufacturing, we estimate the degree of completion for a group of products with respect to
transferred-in, materials, and conversion (direct labor and overhead). Accountants base the concept of
equivalent units on the supposition that a company must incur approximately the same costs to partially
complete a large number of units as to totally complete a smaller number of units.

• Accountants compute equivalent units of production for transferred-in units, materials, and conversion.
For each of these categories, the number of units transferred out is added to the equivalent units remaining in
ending work in process in the department.

• Unit costs for the three categories—transferred-in units, materials, and conversion—are determined by
dividing the equivalent units into the cost in beginning inventory plus the costs transferred in or added in the
department during this period.

• A production cost report shows both the flow of units and the flow of costs through a processing center. The
report is divided into two parts. The first part traces the physical flow of the units through the production
department and converts actual units to equivalent units. The second part shows the costs to be accounted for,
computes unit costs based on equivalent units as determined in the first part, and shows how the costs were
accounted for by adding the costs completed and transferred out with the costs remaining in ending inventory.
The costs to be accounted for and the costs accounted for must balance.

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19. Process: Cost systems

• The production cost report provides a check on the Work in Process Inventory account. Each processing
department normally has its own Work in Process Inventory account and related production cost report. The
separate items that make up work in process inventory—direct labor, direct materials, applied overhead, and
cost of units transferred in and out—can be traced from the production cost report to the Work in Process
Inventory account (and vice versa) during a given period.

• Normal spoilage occurs in the normal course of production and is treated as a product cost. Abnormal
spoilage exceeds the spoilage that occurs in the normal course of production and is treated as a period cost.

• Under FIFO equivalent units of production are computed by taking the equivalent units of work done to
complete the beginning inventory, plus units started and completed during the current period, plus equivalent
units of work done on the ending inventory. As is true under the average cost method, the equivalent units
usually differ between materials and conversion.

• Unit costs for the three categories—transferred-in units, materials, and conversion—are determined by
dividing cost to be accounted for during the period by units produced during the period.

• The physical measures method allocates joint product costs based on physical measures, such as units,
pounds, or liters.

• The relative sales value method is the most commonly used method to allocate joint product costs. It is
based on the relative sales values of the products at the split-off point.
Appendix 19A: The FIFO process cost method
In this chapter, the discussion assumed the use of the average cost method for determining unit costs under
process costing. Another acceptable method for determining unit cost under process costing is the first-in, first-out
(FIFO) cost method. This appendix presents a detailed illustration of the FIFO process costing system.

The following table shows how the computation of equivalent units differs between the average cost method and
the FIFO cost method:
Average cost method FIFO cost method
Equivalent units of production = Units Equivalent units of production = equivalent units
completed this period + Equivalent units of of work done to complete the beginning inventory
work done on the ending inventory + units started and completed this period +
Equivalent units of work done on the ending
inventory

To illustrate the computation of equivalent units under the FIFO method, assume the following facts:
Beginning inventory, 3,000 units, 40% complete
Units started this period, 10,000 units
Ending inventory, 5,000 units, 20% complete

The equivalent production for the period would be:

Equivalent units of work done to complete the beginning inventory 1,800
(3,000 x 0.60)
Units started and completed this period (10,000 – 5,000 in ending 5,000
inventory)
Equivalent units of work done to partially complete the ending 1,000
inventory (5,000 x 0.20)
Equivalent units of production 7,800

As is true under the average cost method, the number of equivalent units usually differs between materials and
conversion.

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FIFO process costing—An illustration

To illustrate more completely the operation of the FIFO process cost method, we use an example of the month of
June production costs for a company having Departments A and B. Both departments add materials only at the
beginning of processing. Department A has no May 31 inventory. The May 31 inventory in Department B consists of
2,000 units that are fully complete as to materials and 50 per cent complete as to conversion. This inventory has
accumulated costs of USD 6,180.

The following transactions and additional data summarize manufacturing operations in both departments for
June:

Raw materials purchased on account, USD 25,000.

Direct materials issued: Department A (14,000 units at USD 1.50), USD 21,000; and Department B (10,000
units at USD 0.13), USD 1,300.

Indirect materials issued: Department A, USD 400; and Department B, USD 200.

Labor costs: direct labor, Department A, USD 6,600, Department B, USD 5,400; and indirect labor, USD 3,000.

Manufacturing overhead is applied as follows: USD 5,280 in Department A and USD 5,400 in Department B.

Other manufacturing overhead incurred:

Repairs (on $2,100
account)
Depreciation 3,000
Utilities (on 3,000
account)
$8,100

• Production reports show the following for June:

Department A Department B
Beginning inventory -0- 2,000
Units started 14,000 10,000
Units completed and transferred out 10,000 9,000
Units in inventory, June 30 4,000 3,000
Estimated percentage 50 33 1/3

• Sales for the month on account, 15,000 units at USD 6 per unit.

• The company computed cost of goods sold at USD 55,866 on a FIFO basis.

The general journal entries and their explanation follow:

1. Materials inventory (+A) 25,000
Accounts payable (+L) 25,000
To record materials purchased on account.

2. Work in process – Department A (+A) 21,000

Work in process – Department B (+A) 1,300
Manufacturing overhead (-SE) 600
Materials inventory (+L) 22,900
To record direct and indirect materials used.

3. Work in process – Department A (+A) 6,600

Work in process – Department B (+A) 5,400
Manufacturing overhead (+SE) 3,000
Payroll summary (-SE) 15,000
To distribute labor.

4. Work in process – Department A (+L) 5,280

Work in process – Department B (-A) 5,400

Accounting Principles: A Business Perspective 20 A Global Text

19. Process: Cost systems

Manufacturing overhead (+A) 10,680

To record assignment of overhead to
production.

5. Manufacturing overhead (-A) 8,100

Accounts payable (+A) 5,100
Accumulated depreciation – Plant and 3,000
equipment (-A)
To record various overhead costs incurred.

6. Work in process – Department B (+A) 24,900

Work in process – Department A (+SE) 24,900
To record transfer of completed production
from Department A to Department B. (For
details of computation, see production cost
report of Department A in Exhibit 6).

7. Accounts receivable (-SE) 90,000

Sales (-A) 90,000
To record sales for the month.

8. Cost of goods sold 55,866

Finished goods 55,866
To record cost of goods sold.

As noted in the journal entries for June's manufacturing operations, the production cost report provided the
dollar amounts of certain entries. For product costing purposes, the production cost report is the primary report in
a process cost system. The chapter illustration of the production cost report shows the units and costs charged to a
department, the disposition of these units and costs, and, typically, some of the supporting details and
computations.

Production cost report—Department A To illustrate flexibility in format, Exhibit 5 shows the production
cost report for Department A in a format different from the one in the chapter. Note that Department A placed
14,000 units into production. Then, Department A completed and transferred out 10,000 units. Department A
retained the remaining 4,000 partially completed units in the department. The footnote in the illustration shows
the computation of equivalent units.
Department A
Production cost report
For the month ended 2011 June 30
Units in beginning inventory -0-
Units started during period 14,000
Units to be accounted for 14,000
Units completed and transferred out 10,000
Units in ending inventory 4,000
Units accounted for 14,000
Costs Equivalent Total Current
units cost unit cost
Costs to be accounted for:
Costs added during the month:
Direct materials 14,000* $21,000 $1.50
Conversion 12,000* 11,880 0.99
Costs added in month and costs $32,880 $2.49
to be accounted for
Costs accounted for:
Cost of ending inventory:
Direct materials (4,000 x 100% $6,000
x $1.50)
Conversion (4,000 x 50% x 1,980
$0.99)
Total cost of ending inventory $7,980
Cost of 10,000 units transferred 24,900 $2.49
out
Costs accounted for $32,880

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*Supporting computations and data:

Materials Conversion
Computations of equivalent units:
Equivalent units to complete beginning -0- -0-
inventory
Units started and completed 10,000 10,000
Equivalent units in partially completed ending 4,000 2,000
inventory
Equivalent units of production for month 14,000 12,000

Materials Conversion
Computations of equivalent units:
Equivalent units to complete beginning -0- -0-
inventory
Units started and completed 10,000 10,000
Equivalent units in partially completed ending 4,000 2,000
inventory
Equivalent units of production for month 14,000 12,000

Exhibit 5: Production cost report—Department A

The costs section of the report shows that the only costs to be accounted for were those added in the department
in June. These costs include USD 21,000 for materials and USD 11,880 for conversion, totaling USD 32,880.
Department A had no beginning inventory and no transfers in. Note how Department A determines its unit costs
for each of the two elements of manufacturing costs (USD 1.50 for materials and USD 0.99 for conversion). The
total current unit cost is USD 2.49. The report shows the disposition of the costs—the cost of the units transferred
to Department B (USD 24,900) and the amount of ending inventory remaining in Department A (USD 7,980 based
on current unit costs). The units transferred to Department B have the same unit cost as the unit cost in
Department A for the month. The current unit cost and the cost of the transferred units is not always the same, as
we will show for Department B in Exhibit 6.
Department B
Production cost report
For the month ended 2011 June 30
Units
Units in beginning inventory 2,000
Units started during period 10,000
Units to be accounted for 12,000
Units completed and transferred out 9,000
Units in ending inventory 3,000
Units accounted for 12,000
Costs Equivalent Total cost Current unit
units cost
Costs to be accounted for:
Costs added during the month:
Direct materials 10,000* $ 1,300 $ 0.13
Conversion 9,000* 10,800 1.20
Costs added during the month $12,100 $ 1.33
Costs in beginning inventory 6,180
Costs transferred in from 24,900
Department A
Total costs to be accounted for $43,180
Costs accounted for:
Cost of ending inventory:
Transferred in from Department $ 7,340
A (3,000 units at $2.49)
Direct materials (3,000 x 100% 390
x $0.13)
Conversion (3,000 x 1/3 x 1,200
$1.20)
Total cost of ending inventory $ 9,060
Cost of 9,000 units transferred 34,120 $3.791
out

Accounting Principles: A Business Perspective 22 A Global Text

19. Process: Cost systems

Costs accounted for $43,180

*Supporting computations and data:
Materials Conversion
Computations of equivalent units:
Equivalent units to complete beginning -0- 1,000
inventory
Units started and completed 7,000 7,000
Equivalent units in partially completed ending 3,000 1,000
inventory
Equivalent units of production for the month 10,000 9,000
Beginning and ending inventories are complete as to materials. Beginning inventory is 50% complete and ending inventory 33 1/2% complete
as to processing.

Exhibit 6: Production cost report—Department B

Production cost report—Department B The production cost report for Department B (Exhibit 6) is similar
to that of Department A. Note how the report highlights the current unit cost of the operations performed in the
department. Note also that Department B must account for the costs in the beginning inventory and the cost of the
units transferred in from Department A. Department B determines the cost of the ending inventory through the use
of the current month's unit cost (USD 1.33). All of Department B's other costs are included in the costs of the 9,000
units transferred to Finished Goods.

In the production cost report in Exhibit 6, we determine the cost of units transferred out by subtracting the cost
of the ending inventory from the total costs to be accounted for (USD 43,180 - USD 9,060 = USD 34,120). We can
compute average unit cost of USD 3.791 by dividing USD 34,120 by the 9,000 units transferred out.
Appendix 19B: Allocation of joint costs
A company incurs joint costs when it produces two or more products through the same production process or
from a common raw material. The company produces these products simultaneously. The products are not
identifiable as different individual products until a particular point in the manufacturing process known as the
split-off point.

The split-off point is a certain stage of production at which the separate products become identifiable from a
common processing unit. We refer to any costs beyond the split-off point as separable costs because they can be
directly traced to individual products. Examples of joint products are petroleum products, lumber, flour milling,
dairy products, and chemicals. In Exhibit 7, we show the joint production process.

By definition, joint costs are not identified with individual products. Any allocation of joint costs to one of the
products is inherently arbitrary. Many companies do not allocate joint costs to particular products for managerial
decision making because the allocated numbers could be misleading to decision makers. 1 The accounting problem
we face is how to allocate the joint costs that a company incurred before the products become separately identified.
Commonly used methods to allocate joint costs are the physical measures method and the relative sales value
method.

The physical measures method allocates joint costs on the basis of physical measures such as units, pounds,
or liters.

1 For example, a survey of oil refineries indicated that seven of the nine companies did not allocate joint costs. See
K. Slater and C. Wooton, A Study of Joint and By-Product Costing in the U.K. (Reprint, London: Chartered
Institute of Management Accountants, 1988), p. 110.

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To illustrate, assume that Roy Company produces two grades of oil, product A and product B, through a joint
process. The cost and production data of Roy Company for July are:
Product AProduct B Total
Units (barrels) produced 15,000 25,000 40,000
Unit selling price at split-off $ 15 $6
Revenue at split-off $225,000 $150,000
Joint product costs:
Direct materials $125,000
Direct labor 105,000
Manufacturing overhead 70,000
$300,000

Exhibit 7: Production cost report-Department B

The physical measures method uses a ratio of the physical volume of each product to total volume as a basis for
allocation of joint costs. We compute the allocation of joint costs to each product as follows:
Total Ratio Joint Allocated
barrels costs joint costs
Product A 15,000 15,000 X $300,000 $112,500
40,000
Product B 25,000 25,000 X $300,000 187,500
40,000
40,000 $300,000

If Roy Company sells both products without further processing, the gross margin for product A is USD 112,500,
or USD 225,000 less USD 112,500. Product B incurs a loss of USD 37,500, or USD 150,000 less USD 187,500. Even
though the physical measures method is easy to use, it often has no relationship to the revenue-generating power of
each product. In this instance, product B suffers a loss of USD 37,500 because the company allocated a high portion
of joint costs based on product B's high volume of physical units even though its selling price is less than that of
product A.

Keep in mind that the joint costs cannot be directly assigned to one product because joint costs are inseparable
between the products. Thus, because any allocation of joint costs to one product is arbitrary, the resulting measures
of each product's income are arbitrary.

The relative sales value method is a commonly used basis to allocate joint costs at the split-off point.
Accountants use the relative sales value method because it matches joint costs with revenue much like the matching
concept.

Using the relative sales value method, Roy Company would allocate the joint costs as follows:
Sales value Ratio Joint Allocated
at split-off costs joint
costs
Product A: $225,000 $225,500 X $300,000 $180,000
($15 x 15,000) $375,000
Product B: 150,000 $150,000 X $300,000 120,000
($6 x 25,000) $375,000
$375,000 $300,000

Accounting Principles: A Business Perspective 24 A Global Text

19. Process: Cost systems

The allocation ratios of 60 per cent and 40 per cent, respectively, for product A and product B result in allocated
joint costs of USD 180,000 to product A, and USD 120,000 to product B.

To compare the physical measures method and the relative sales value method, assume Roy Company has no
inventory at the end of July. A partial July income statement would appear as shown:
Product A Product B
Physical Relative Physical Relative
Measures Sales Value Measures Sales Value
Method Method Method Method
Sales $225,000 $225,000 $150,000 $150,000
Cost of goods sold 112,500 180,000 187,500 120,000
Gross margin $112,500 $ 45,000 $(37,500) $ 30,000
Demonstration problem
Zarro, Inc., uses a process cost system to accumulate the costs it incurs to produce aluminum awning stabilizers
from recycled aluminum cans. The May 1 inventory in the finishing department consisted of 36,000 units, fully
complete as to materials and 80 per cent complete as to conversion. The beginning inventory cost of USD 288,000
consisted of USD 216,000 of costs transferred in from the molding department, USD 30,000 of finishing
department materials costs, and USD 42,000 of finishing department conversion costs (conversion costs are direct
labor and overhead). The costs incurred in the finishing department for May appear as follows:
Costs transferred in from molding department $720,000
(excluding costs in beginning inventory)
Costs added in finishing department in May
(excluding costs in beginning inventory): $63,600
Materials 131,376 194,976
Conversion costs $914,976

The finishing department received 120,000 units from the molding department in May. During May, 127,200
units were completed by the finishing department and transferred out. As of May 31, 28,800 units, complete as to
materials and 60 per cent complete as to conversion, were left in inventory of the finishing department.

a. Using the average cost procedure, prepare a production cost report for the finishing department for May.

b. Compute the average unit cost for conversion in the finishing department in April.
Solution to demonstration problem
a.
Zarbo, Inc.
Finishing department
Production cost report
For the month ending Equivalent
May 31 units
Units Actual units Transferred Materials Conversion
-in
Units in May 1 inventory 36,000
Units transferred in 120,000
Units to be accounted for 156,000
Units completed and 127,000 127,200 127,200 127,200*
transferred out
Units in May 31 inventory* 28,800 28,800 28,800 17,280†
Units accounted for 156,000 156,000 156,000 144,480
*Inventory is complete as to materials, 60% complete as to conversion.
†(28,800 x 60% = 17,280).
Costs Transferred Materials Conversion Total
-in
Costs to be accounted for:
Costs in May 1 inventory $216,000 $30,000 $42,000* $288,000
Costs transferred in 720,000 720,000

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Costs added in 63,600 131,376 194,976

department
Costs to be accounted for $936,000 $93,600 $ 173,376 $1,202,976
Equivalent units (from 156,000 156,000 144,480
above)
Unit costs $ 6.00 $ 0.60 $ 1.20 $7.80
Costs accounted for:
Units completed and $763,200 $76,320 $ 152,640* $992,160
transferred out (127,200
units)
Units remaining in May 31 172,800 17,280 20,736* 210,816
inventory (28,800 units)
Costs accounted for $936,000 $93,600 $173,376 $1,202,976
*17,280 equivalent units x $1.20 = $20,736.

b. The average unit cost for conversion in the finishing department in April was USD 1.46, calculated as
USD 42,000
.
0.8×36,000

Key terms
Abnormal spoilage Spoilage that exceeds the amount expected under normal operating conditions.
Average cost procedure A method of computing equivalent units where the number of equivalent units
for each cost element equals the number of units transferred out plus the number of equivalent units of that
cost element in the ending inventory.
Conversion costs Costs of converting raw materials into the final product. Direct labor plus overhead.
Equivalent units A method of expressing a given number of partially completed units as a smaller number
of fully completed units; for example, bringing 1,000 units to a 75 per cent level of completion is the
equivalent of bringing 750 units to a 100 per cent level of completion.
First-in, first-out (FIFO) method A method of determining unit cost. This method computes equivalent
units by adding equivalent units of work needed to complete the units in beginning inventory, work done on
units started and completed during the period, and work done on partially completed units in ending
inventory.
Job cost system (job costing) A manufacturing cost system that accumulates costs incurred to produce a
product according to individual jobs.
Joint costs Those production costs incurred up to the point where the joint products split off from each
other.
Normal spoilage Spoilage that occurs in the normal production process.
Physical measures method A method of allocating joint product costs on the basis of physical measures
such as units, pounds, or liters.
Process cost system (process costing) A manufacturing cost system that accumulates costs incurred to
produce a product according to the processes or departments a product goes through on its way to
completion.
Production cost report A report that shows both the flow of units and the flow of costs through a
processing center. It also shows how accountants divide these costs between the cost of units completed and
transferred out and the cost of units still in the processing center's ending inventory.
Relative sales value method A method of allocating joint product costs on the basis of the relative market
value at the split-off point.
Split-off point A certain stage of production at which the separate products become identifiable from a
common processing unit.
Spoilage The loss of goods during production.
Transferred-in costs Costs associated with physical units that were accumulated in previous processing
centers.
Self-test
True-false

Indicate whether each of the following statements is true or false.

Accounting Principles: A Business Perspective 26 A Global Text

19. Process: Cost systems

In process costing, costs are accumulated by process or department.

Both job and process cost systems can only have one Work in Process Inventory account.

The first step in computing equivalent units is to determine the amount of materials being used.

Abnormal spoilage is treated as a product cost.

(Based on Appendix 19-B.) A commonly used basis to allocate joint costs is the relative sales value of the
products at the split-off point.

Multiple choice

Select the best answer for each of the following questions.

Which of the following does not apply to process costing?

a. Uses the equivalent unit concept.

b. Includes overhead in product costs.

c. Costs of production are first recorded in Work in Process Inventory accounts then transferred to Finished
Goods Inventory and Cost of Goods Sold.

d. Keeps track of the actual cost of each individual unit produced.

Which of the following formulas is the correct formula for equivalent units of production under the average cost
procedure?

a. Units completed - [Units in ending inventory X Percentage complete] = Equivalent production

b. Units completed - [Units in beginning inventory X Percentage complete] = Equivalent production

c. Units completed + [Units in ending inventory X Percentage complete] = Equivalent production

d. None of the above.

Using the following data, compute the ending inventory cost:

1,000 units are in ending inventory in Department B. The 1,000 units are fully complete as to materials and 20
per cent complete as to conversion. The unit cost for materials is USD 0.05, and conversion unit cost equals USD
0.60. The unit cost of goods transferred in from Department A is USD 1.20.

a. USD 1,370.

b. USD 1,170.

c. USD 1,320.

d. USD 1,250.

A production cost report reports which of the following:

a. Units in a production department.

b. Costs related to production.

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c. Unit costs.

d. Equivalent units.

e. All of the above are included in the production cost report.

(Based on Appendix 19-A) Compute the equivalent units of production under the FIFO method using this data:

Beginning inventory, 1,500 units—40 per cent complete

Units started this period, 5,000 units

Ending inventory, 2,500 units—20 per cent complete

a. 3,000.

b. 3,900.

c. 3,400.

d. 3,600.

Now refer to “Answers to self-test” at the end of the chapter to check your answers.

Questions
➢ Define process costing and describe the types of companies that use process costing.

➢ How does a process cost system differ from a job costing system?

➢ Would a lumber mill use process or job costing?

➢ What is meant by the term equivalent units? Of what use is the computation of the numbers of
equivalent units of production?

➢ Distinguish between the number of units completed and transferred during a period and the
equivalent units for the same period.

➢ Under what circumstances would the number of equivalent units of materials differ from the number
of equivalent units of labor and overhead in the same department in the same period? Under what
circumstances would they be the same?

➢ When transferring goods from one department to another, which accounts require journal entries?

➢ Units are usually assumed to be at the same stage of completion for both labor and overhead. What is
the reason for this assumption?

➢ What is the basic information conveyed by a production cost report?

➢ What are the four steps in preparing a production cost report?

➢ What is meant by average cost procedure? What other two cost flow assumptions could be used?

➢ Would an automobile plant that makes specialty race cars use job costing or process costing? Would
an automobile plant that makes all terrain vehicles use job costing or process costing? Explain your
answer.

Accounting Principles: A Business Perspective 28 A Global Text

19. Process: Cost systems

➢ What is the difference between normal and abnormal spoilage?

➢ Why might an advocate of total quality management prefer to see all spoilage labeled as abnormal?

➢ Show the differences between computing equivalent units of production using the average cost
method and FIFO cost method (Appendix 19A).

➢ Describe the relative sales value method and show how it is used (Appendix 19B).

➢ Real world question Refer to "A broader perspective: Producing cans of Coca-Cola". Describe the
different processes used in a cola bottling plant.

➢ Real world question Does The Coca-Cola Company use a process cost system or a job costing
system in its bottling plants? Why?

➢ Real world question Name five companies that probably use process costing.
Exercises
Exercise A Using the average cost method, compute the equivalent units of production in each of the following
cases:

a. Units started in production during the month, 72,000; units completed and transferred, 52,800; and units in
process at the end of the month (100 per cent complete as to materials; 60 per cent complete as to conversion),
19,200. (There was no beginning inventory.)

b. Units in process at the beginning of the month (100 per cent complete as to materials; 30 per cent complete as
to conversion), 12,000; units started during the month, 48,000; and units in process at the end of the month (100
per cent complete as to materials; 40 per cent complete as to conversion), 24,000.

Exercise B In Department C, materials are added at the beginning of the process. There were 1,000 units in
beginning inventory, 10,000 units were started during the month, and 7,000 units were completed and transferred
to finished goods inventory. The ending inventory in Department C in June was 40 per cent complete as to
conversion costs. Under the average cost method, what are the equivalent units of production for materials and
conversion?

Exercise C In Department D, materials are added uniformly throughout processing. The beginning inventory
was considered 80 per cent complete, as was the ending inventory. Assume that there were 6,000 units in the
beginning inventory and 20,000 in the ending inventory, and that 80,000 units were completed and transferred
out of Department D. What are the equivalent units for the period using the average cost method?

Exercise D If in the previous exercise the total costs charged to the department amounted to USD 960,000,
including the USD 48,000 cost of the beginning inventory, what is the cost of the units completed and transferred
out?

Exercise E The following data relate to Work in Process—Department C, in which all materials are added at the
start of processing:
Work in process – Department C:
Inventory, March 1:
Materials cost (1,200 pounds; 100% $7,020
complete)

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Conversion cost (20% complete) 1,804

Costs incurred this period:
Direct materials used (9,000 pounds) $36,330
Direct labor 10,880
Overhead 17,820
Inventory, March 31
Materials cost (1,800 pounds, 100% ?
complete)
Conversion cost (1,800 pounds, 80% ?
complete)
Pounds of product transferred out: 8,400

Using these data, compute:

a. The unit cost per equivalent unit for materials and conversion (use the average cost method).

b. The cost of the product transferred out.

Problems
Problem A The following data refer to a production center of Sipp-Fizz, a soft drink bottler:
Work in process inventory, August 1, 4,000 units
(units equal 12-bottle cases):
Direct materials $12,000
Direct labor 6,120
Manufacturing overhead applied 8,000
$26,120
Units started in August 12,000
Costs incurred in August:
Direct materials $36,000
Direct labor 48,000
Manufacturing overhead applied 60,000

The beginning inventory was 100 per cent complete for materials and 50 per cent complete for conversion costs.

The ending inventory on August 31 consisted of 6,000 units (100 per cent complete for materials, 70 per cent
complete for conversion costs).

Compute the following:

a. Number of units completed and transferred to finished goods inventory.

b. The equivalent units of production for materials and conversion costs using the average cost method.

c. Cost per equivalent unit for materials and conversion costs.

d. Cost of units completed and transferred.

e. Cost of ending inventory.

Problem B The following information relates to Aromatic Company for its line of perfume products for the
month ended March 31:
Units in beginning inventory (units 2,7000
equal cases of product)
Cost of units in beginning inventory:
Materials $40,500
Conversion $ 18,900
Units placed in production 54,000
Cost incurred during current period:
Materials $239,598
Conversion $215,310
Units remaining in ending 3,000
inventory
(100% complete as to materials,

Accounting Principles: A Business Perspective 30 A Global Text

19. Process: Cost systems

60% complete as to conversion)

Prepare a production cost report for the month ended March 31, using the average cost method.

Problem C Shine Company uses a process cost system to account for the costs incurred in making its single
product, a hair conditioner. This product is processed in Department A and then in Department B. Materials are
added in both departments. Production for May was as follows:
Department A Department B
Units started or transferred in 200,000 160,000
Units completed and transferred out 160,000 120,000
Stage of completion of May 31 inventory:
Materials 100% 80%
Conversion 50% 40%
Costs incurred this month:
Direct materials costs $200,000 $304,000
Conversion costs $540,000 $272,000

There was no May 1 inventory in either department.

a. Prepare a production cost report for Department A in May.

b. Prepare a production cost report for Department B in May.

Problem D A bottling company bottles soft drinks using a process cost system. Following are cost and
production data for the mixing department for June:
Units Materials Conversion
costs costs
Inventory, June 1 56,000 $11,620 $16,240
Placed in production in June 133,000 29,960 41,720
Inventory, June 30 63,000 ? ?

The June 30 inventory was 100 per cent complete as to materials and 30 per cent complete as to conversion.

Prepare a production cost report for the month ended June 30 using the average cost method.

Problem E Refer to the facts given in the previous problem. Assume the beginning inventory on June 1 was 100
per cent complete as to materials and 25 per cent complete as to conversion.

a. Prepare a production cost report for the month ended June 30, using FIFO. Round unit costs to the nearest
cent.

b. Why are ending inventory amounts different than those for the previous problem?

Problem F Quality Lumber Company produces two products from logs, Grade A lumber and Grade B lumber.
The following events took place in June:
Grade A Grade B Total
Units produced 80,000 120,000 200,000
Unit selling price at split-off $4.00 $2.00
Joint costs ? ? $120,000

a. Allocate the joint costs to the two products using the physical measures method.

b. Allocate the joint costs to the two products using the relative sales value method.

c. Explain the difference in unit costs using the two methods.

d. What are advantages of the relative sales value method if all of Grade A lumber has been sold and none of
Grade B lumber has been sold at the end of a month?

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Alternate problems
Alternate problem A Pure Aqua Company is a producer of flavored mineral water. These data are for its
March production:
Work in process inventory, March 1, 3,000 (units equal
cases):
Direct materials $12,600
Direct labor 6,000
Manufacturing overhead (1,500 machine-hours at $6 per 9,000
machine-hours)
$27,600
Units started in March 9,000
Costs incurred in March:
Direct materials $36,360
Direct labor 55,200
Manufacturing overhead applied (13,800 machine-hours) ?

The ending inventory consisted of 4,500 units (100 per cent complete as to materials, 60 per cent complete as to
conversion).

Compute the following:

a. Number of units completed and transferred to finished goods inventory.

b. The equivalent units of production for materials and conversion costs using the average cost method.

c. Cost per equivalent unit for materials and conversion costs.

d. Cost of units completed and transferred.

e. Cost of ending inventory.

Alternate problem B The following data pertain to a production center of Sunbelt Company, a maker of
sunscreen products:
Units Materials Conversion
costs costs
Inventory, October 1 70,000 $12,000 $16,000
Placed in production in October 200,000 20,400 18,200
Inventory, October 31 100,000 ? ?

The October 31 inventory was 100 per cent complete as to materials and 20 per cent complete as to conversion
costs.

Prepare a production cost report for the month ended October 31, using the average cost method.

Alternate problem C Healthbar Company produces a health food and determines product costs using a
process cost system. The product is moved through two departments, mixing and bottling. Production and cost data
for the bottling department in August follow.
Work in process, August 1 (30,000 pints):
Costs transferred in $30,000
Materials costs 15,000
Conversion costs 9,000
Costs incurred in August:
Transferred in (100,000 pints) $100,00
0
Materials costs 50,000
Conversion costs 39,300

All materials are added at the beginning of the bottling process. Ending inventory consists of 25,000 pints, 100
per cent complete as to materials and 40 per cent complete as to conversion.

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19. Process: Cost systems

Prepare a production cost report for August using the average cost method.
Beyond the numbers—Critical thinking
Business decision case A Bicycles Plus, Inc., produces bicycles. While the company has developed a per unit
cost, it has not been able to break down its costs in each of its three departments: frames, assembling, and finishing.
Karol Ring, the production manager, has been concerned with cost overruns during July in the frames department,
which produces the bicycle frames.

On July 1, the frames department had 6,000 units in its work in process inventory. These units were 100 per
cent complete as to materials and 40 per cent complete as to conversion. The department had incurred USD 12,000
in materials costs and USD 90,000 in conversion costs in processing these 6,000 units.

The department handled 30,000 units during the month, including the 6,000 units in beginning inventory on
July 1. At the end of the month, the department's work in process included 3,600 units that were 100 per cent
complete as to materials and 30 per cent complete as to conversion. The month's costs were allocated on the
number of units processed during the month as follows:
Materials Conversion
Costs $60,000 $300,216
Units handled during month 30,000 30,000
Cost per unit $2 $ 10

The USD 12 per unit cost was assigned in a way that resulted in the following costs:
Beginning Work Ending work
work started in process
in process and
completed
Cost per unit incurred during the
month:
Units 6,000 20,400 3,600
Cost per unit $12 $12 $12

Ring realized that this per unit cost is incorrect and asks you to develop a better method of computing these
costs for the month ended July 31.

a. How would you recommend that July's costs be assigned to the units produced? How would this differ from
the present method?

b. To justify your recommendation, recalculate July's costs using your recommendation. Present your analysis in
a production cost report.

Ethics case – Writing experience B Steve Yung works in the inventory control group at a company that
produces stone-washed jeans. A good friend manages the Stitching Department at the same company. At the end of
a recent month, Yung reviewed the Stitching Department's production cost report and found the department had
no beginning Work in Process Inventory, had started 27,000 pairs of jeans, and had produced only 24,000 pairs.
That leaves 3,000 pairs in ending inventory, Yung thought, that is a lot of jeans they did not finish.

Later, Yung visited his friend who managed the Stitching Department. "Why all the ending inventory?" he asked.

"One of the new workers set several machines wrong, and the stitching was bad on 2,400 pairs," the manager
replied. "We set those aside, and we will fix them when we have some free time. The other 600 pairs are complete
now, and have been transferred out. Our entire operation was slower because of the machine problem."

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"Company policy is to send all defective products to the Rework Department. They can fix the jeans. That is their
job," Yung said.

“No way!" exclaimed the Stitching Department manager. "We would all be in trouble if plant management finds
out. The worker who messed up would probably be fired. I do not want that. This is our little problem, and we will
take care of it."

a. What should Yung do?

b. Would your answer change if Yung learned that the Stitching Department had fixed the jeans and sent them
on to the next department?

Financial analysis C Suppose a bottling company made an error in estimating the stage of completion of its
work in process inventory. Suppose the costs in beginning inventory and the costs transferred in were correct, but
the company overstated the stage of completion for both materials and conversion costs in ending Work in Process
Inventory causing ending Work in Process Inventory to be USD 100,000 too high. The beginning and ending
Finished Goods Inventory amounts are correct. What effect would this error have on the company's last year's
financial statements?

Group project D In groups of 3 or 4 students, write a paper on the topic, "How scientific is the allocation of
joint costs to products?" Prepare the paper on a computer and prepare and edit several drafts before turning in the
final paper. Use examples to demonstrate your points.

Group project E In teams of two or three students, interview the manager of a grocery store. What is the cost
of spoilage in the vegetable and fruit section as a percentage of the total cost of goods sold? Does the manager
differentiate between normal and abnormal spoilage? If so, provide some examples. Each team should write a
memorandum to the instructor summarizing the results of the interview. Information contained in the memo
should include:

Date:

To:

From:

Subject:

Content of the memo must include the name and title of the person interviewed, name of the company, and
information responding to the questions above.

Group project F In teams of two or three students, interview the manager of a fast food restaurant such as
McDonald's. What is the cost of spoilage as a percentage of the total cost of goods sold? Does the manager
differentiate between normal and abnormal spoilage? If so, provide some examples. Each team should write a
memorandum to the instructor summarizing the results of the interview. Information contained in the memo
should include:

Date:

To:

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19. Process: Cost systems

From:

Subject:

Content of the memo must include the name and title of the person interviewed, name of the company, and
information responding to the questions above.
Using the Internet—A view of the real world
Using the Internet as a research tool, describe the conversion activities (or processes) involved in producing oil
or oil-related products. Your description should include examples of raw materials used as inputs, production
activities required to convert inputs into products, and resulting outputs (finished goods). Write your report in the
form of a memorandum. The heading of the memorandum should contain the date, to whom it is written, from
whom, and the subject matter. Be sure to attach your research materials obtained from the Internet to the
memorandum.

Using the Internet as a research tool, describe the conversion activities (or processes) involved in producing
milk or milk-related products. Your description should include examples of raw materials used as inputs,
production activities required to convert inputs into products, and resulting outputs (finished goods). Write your
report in the form of a memorandum. The heading of the memorandum should contain the date, to whom it is
written, from whom, and the subject matter. Be sure to attach your research materials obtained from the Internet to
the memorandum.
Answers to self-test
True-false

True. In process costing, costs are accumulated by process or department.

False. Job cost systems have one Work in Process Inventory account for each job, and process cost systems
have a Work in Process Inventory account for each process or department.

False. The initial step in computing equivalent units is to determine either the stage of completion or the
number of partially complete units.

False. Abnormal spoilage is treated as a period cost.

True. The relative sales value of the products at the split-off point is a commonly used basis to allocate joint
costs.

Multiple-choice

d. Process costing does not keep track of the actual cost of each individual unit produced.

c. Units completed + [Units in ending inventory X Percentage complete] = Equivalent production

a. USD 1,370 [USD 1,200 + (1,000 X USD .05) + (200 X USD .60)]

e. Items a through d are included in the production cost report.

b. The equivalent production for the period would be:

Equivalent units of work done to complete the 900
beginning inventory
(1,500 x 0.60)

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Units started and completed this period (5,000 – 2,500

2,500)
Equivalent units of work done to partially complete the 500
ending
inventory (2,500 x 0.20)
Equivalent units of production 3,900
Comprehensive review problem
The Compack Company assembles personal computers. Personal computers go through several departments
where sub assemblies are unpacked and checked, the circuit board is attached, the product is tested and repaired if
defective, and the computers are packed carefully for shipping. Each order is treated as a job, and the entire job is
shipped at once. The company keeps track of costs by job and calculates the equivalent stage of completion for each
job based on machine-hours.

Although the company has grown rapidly, it has yet to show a profit. You have been called in as a consultant.
Management believes some jobs are profitable and others are not, but it is not clear which are profitable. The
accounting system is almost nonexistent; however, you piece together the following information for April:

• Production:

a. Completed Job No. 101.

b. Started and completed Job No. 102.

c. Started Job No. 103.

• Inventory values:

a. Work in process inventory:

March 31: Job No. 101
Direct materials $60,000
Direct labor 9,600
Overhead 14,400
April 30: Job No. 103
Direct materials $45,000
Direct labor 10,400
Overhead 15,600

b. Job No. 101 was exactly one-half finished in direct labor-hours and machine-hours at the beginning of April,
and Job No. 103 was exactly one-half complete in direct labor-hours and machine-hours at the end of April.
However, all of the direct materials necessary to do the entire job were charged to each job as soon as the job was
started.

c. There were no direct materials inventories or finished goods inventories at either March 31 or April 30.

• Manufacturing overhead is applied at USD 30 per machine-hour. The company used 1,600 machine-hours
during April, 480 machine-hours on Job 101 and 600 machine-hours on Job 102. The actual overhead for the
month of April was USD 50,000.

• Cost of goods sold (before adjustment for over applied or under applied overhead):
Job No. 101:
Materials $60,000
Labor ?
Overhead ?
Total ?
Job No. 102:
Materials ?

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19. Process: Cost systems

Labor ?
Overhead ?
Total ?

• Overhead was applied to jobs using the predetermined rate of USD 30 per machine-hour. The same rate
had been used since the company began operations. Over- or under applied overhead is debited or credited to
Cost of Goods Sold.

• All direct materials were purchased on account. Direct materials purchased in April amounted to USD
150,000.

• Direct labor costs charged to jobs in April were USD 32,000. All labor costs were the same rate per hour for
April for all laborers.

a. Compute the cost of each job, whether in inventory or sold.

b. Show the transactions in journal entry form. Use a separate Work in Process Inventory account for each job.

c. Prepare an income statement for April assuming revenue was USD 250,000 and selling and administrative
expenses were USD 60,000.

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