Process Costing

Learning Objectives:
I. Nature and Operations
II. Cost of Production: Average Costing
III. Cost of Production Report: FIFO Costing
IV. Accounting for Normal and Abnormal Spoilage
V. Measurement of Ending Inventory,Transferred goods and Work in Process related to
spoilage
VI. Discrete and continuous

Nature and Operation

Process costing is a method used in cost accounting to determine the cost of producing a
product by allocating costs to each stage of production. It's commonly used in industries
where products are manufactured through a continuous or repetitive process, such as food
processing, chemical manufacturing, and textile production.

In process costing, the production process is divided into distinct stages or departments, each of which
incurs costs. These costs include direct materials, direct labor, and manufacturing overhead. The total
costs incurred in each department are then allocated to the units produced during the period, typically
based on a predetermined allocation method such as the number of units produced, machine hours
used, or direct labor hours worked.
Comparison of Job order Costing and Process Costing

Introduction to Process Costing

The first step is to accumulate all costs incurred in each production department. These costs
include direct materials, direct labor, and manufacturing overhead. Direct materials are typically
tracked through material requisition forms, while direct labor costs are recorded based on employee
time cards or other tracking systems. Manufacturing overhead costs, such as rent, utilities, and
depreciation, are allocated to production departments based on predetermined allocation bases, such
as machine hours or direct labor hours.
It uses averaging process in assigning cost to product units. In the simplest situation, a product’s
actual unit cost is found by dividing a period’s departmental production costs by that period’s
department production quantity. It goes like this:

Unit Production Costs

=
Cost Production Quantity

Equivalent Units of Production

This is a concept used in process costing to measure the amount of work done during a period,
expressed in terms of fully completed units. In industries where products are manufactured through
continuous or repetitive processes, not all units are completed at the same time. Some may be partially
completed at the end of the period.
Equivalent units of production (EUP) represent the number of fully completed units number that
could have been produced during a period from the actual resources expended during that period.
EUP is calculated to equate partially completed units to fully completed units, making it easier to
allocate costs accurately.
Illustration:
If 1,000 units are partially completed at the end of the period and these are 60% complete, then the
equivalent units would be 600 (1,000 units * 60% completion), meaning that the effort expended
during the period is equivalent to 600 fully completed units.

Process Costing Method

The two methods of accounting for cost flows in process costing are
• weighted average (WA) and
• first-in, first-out (FIFO).
The methods reflect the way in which cost flows are assumed to occur in the production process. In a
very general way, these process costing approaches can be related to the cost flow methods used in
financial accounting.

Weighted Average Method First in- First out Method

Cost Flow Under this method, the costs of FIFO follows a chronological order of
beginning WIP inventory and costs cost flow, where costs associated with
incurred during the current period are units completed during the period are
pooled together and divided by the total assigned based on the costs of units
equivalent units of production to from the beginning WIP inventory.
determine the cost per equivalent unit.
Cost It assumes costs incurred during the It assumes that units started and
Calculation period are combined with the costs of completed during the period are costed
beginning work in process (WIP) using the costs of the earliest units
inventory to calculate the cost per (first-in) in the beginning work in
 equivalent unit. process (WIP) inventory. The costs of
units in ending WIP inventory are
costed using the costs incurred during
the current period.
Calculation Equivalent units are calculated based on Equivalent units are calculated
of EUP the average degree of completion of considering the worked performed to
units. This means that the costs incurred Beginning inventory last period period .
during the period are spread evenly The units completed during the period
across all units produced, regardless of use the costs of the beginning WIP
when they were started. inventory, while the units in ending
WIP inventory use the costs incurred
during the current period.
Simplicity The weighted average method is simpler It requires tracking the costs of units
to compute because it combines costs separately, which means identifying
from both the current period and which costs belong to units from the
beginning inventory. beginning inventory and which belong
to units produced during the current
period.

Steps to be followed in Process Costing

Step 1: Calculate the total physical units for which the department is responsible.
Step 2: Calculate the total physical units.
Step 3: Determine the EUP for each cost component.
Step 4: Calculate the total cost to account for.
Step 5: Calculate the cost per equivalent unit for each cost component
Step 6: Assign production costs to inventory

Step 1: Calculate the total physical units for which the department is responsible.
This amount is the sum of fully and partially completed units processed in the department during the
current period:

TOTAL UNITS TO
= Beg. WIP inventory Units + Units started this period
ACCOUNT FOR

Step 2: Calculate the total physical units.

This calculation requires a determination of what happened to the units during the period. At period-
end, the total physical units will be either:
a. completed and transferred out
b. partially completed and remaining in ending WIP Inventory

TOTAL UNITS Completed Units+ Partially completed units in Ending

=
ACCOUNTED FOR WIP inventory
After calculating Total units accounted for, verify that the total units to account for are equal to the
total units accounted for. If these amounts are not equal, any additional computations will be
incorrect.
Step 3: Determine the EUP for each cost component.
EUP is calculated to equate partially completed units to fully completed units, making it easier to
allocate costs accurately.
In this step we will use either the WA or FIFO method. Take note of the following scenario.
 a. If all direct material is added at the same stage of completion, a SINGLE computation for
direct material can be made.
b. If multiple materials are used but placed into production at different points in the
production process, MULTIPLE direct material EUP calculations are necessary.
c. If overhead is based on direct labor or if these two factors are always at the same degree of
completion, a SINGLE EUP can be computed for conversion.
d. If neither condition exists, SEPARATE EUP schedules must be prepared for labor and
overhead

Cost Component
Direct material Conversion cost
Units in Beginning WIP inventory xxx xxx
Units Started and Completed during the xxx xxx
period
Units in Ending WIP inventory xxx xxx
Equivalent Units of Production xxx xxx

Difference in Calculation EUP per cost component of BWIP

Weighted Average Method FIFO method
Assumes work performed last period Assumes work performed last period is not
commingled with work of the current period. It commingled with work of the current period.
shows Beginning WIP inventory in the EUP Only the work performed on the beginning WIP
schedule in full units. Inventory during the current period is shown in
the EUP schedule;

Step 4: Calculate the total cost to account for.

This amount pertain to the beginning balance in WIP Inventory plus all current costs for direct
material, direct labor, and overhead.

TOTAL COST TO Cost of Beg. WIP + Cost incurred for DM,DL and OH
=
ACCOUNT FOR for the current period

Step 5: Calculate the cost per equivalent unit for each cost component
Cost Component
Direct Material Conversion Cost
Cost of Direct Material Cost of Conversion Cost
EUP for DM EUP for CC

Step 6: Assign production costs to inventory

Use the costs computed in step 5 to assign production costs to units completed and transferred out of
WIP Inventory and to units remaining in WIP Inventory.

TOTAL COST TO Total Cost of Transferred Out of WIP +Cost of Ending

=
ACCOUNT FOR WIP

Comprehensive Sample Problem:

Candles in beginning WIP Inventory
(40% complete as to labor and overhead or conversion) 10,000
Candles started during current period 401,400
Candles completed and transferred to FG Inventory 406,000
Candles in ending WIP Inventory
(80% complete as to labor and overhead or conversion) 5,400
Costs of beginning WIP Inventory
Direct material P11,886
Direct labor 5,658
Overhead 19,858 P37,402
Current period costs
Direct material P642,240
Direct labor 122,638
Overhead 385,262 1,150,140
Total cost to account for P1,187,542
Step Weighted Average First in-First out (FIFO)
Step 1: Candles in beginning SAME WITH WA
WIP Inventory 10,000
Candles started during
current period 401,400
Candles to account for 411,400
Step 2: Candles completed SAME WITH WA
during the period 406,000
Candles partially
completed in Ending WIP 5,400
Candles accounted for 411,400
Step 3:

Step 4:

Step 5:

Step 6:

Cost of Production Report: WA method

Cost of Production Report: FIFO method
Process Costing when there in a multiple departments
In a multidepartment production environment, goods are transferred from a predecessor (upstream)
department to a successor (downstream) department. Costs of the completed units of predecessor
departments are treated as input costs in successor departments. Such a sequential treatment requires
the use of an additional cost component called transferred-in cost or prior department cost.
The transferred-in cost component is treated the same as any other cost component in the calculations
of EUP and cost per EUP.

Accounting for Spoilage

Almost every process produces some units that do not meet production specifications. In other
situations, addition or expansion of materials after the start of the process may cause the number of
units accounted for to be higher than those to be accounted for originally or in a previous department.
Losses in a production process may occur continuously or at a specific point.
a. Continuous Loss - it occurs fairly uniformly through the process.
b. Discrete Loss - it assumes to occur at a specific point and is detectable only when a quality
check is performed.
Several methods can be used to account for units lost during production. Selection of the most
appropriate method depends on whether the loss is considered normal or abnormal and whether the
loss occurred continuously in the process or at a discrete point.

Comparison of Continuous and Discrete

The costs of normal shrinkage and normal continuous losses in a process costing environment are
accounted for using the method of neglect, which excludes the spoiled units in the equivalent units
of production schedule. Ignoring the spoilage results in a smaller number of EUP, and dividing
production costs by a smaller EUP raises the cost per equivalent unit. Thus, the cost of lost units is
spread proportionately over the good units transferred out and those remaining in WIP Inventory.
Alternatively, the cost of normal discrete losses should be assigned only to units that have passed the
inspection point. Such units should be good units (relative to the inspected characteristic), whereas the
units prior to this point may be good or they may be defective or spoiled. Assigning loss costs to units
that may be found to be defective or spoiled in the next period would not be reasonable.

Illustration of Discrete Approach to Losses

E.I.T
EWIP % of
Inspection point
0% Completion is 100%
is at 60%
50%

0%
Inspection point
is at 60%
EWIP % of
Completion is
80%
100%
I.E.T
SAMPLE PROBLEM
ABC company manufactures Jar and uses process costing.
The following are the production information for the month.

Jars
Beginning WIP Inventory (60% complete) 12,000
Started during month 90,000
Jars completed and transferred 79,200
Ending WIP Inventory (75% complete) 15,000

Normal Spoilage are equivalent to 5% of units started

Costs
Beginning WIP Inventory:
Material P 16,230
Conversion 3,459 P 19,689
Current period
Material P101,745
Conversion 19,041 P 120,786
Total cost to be accounted for P 140,475

ABC uses weighted average cost flow method.

Step Continuous Discrete

Step 1: Jars in beginning SAME WITH CONTINUOUS
WIP Inventory 12,000
Jars started during
current period 90,000
Jars to account for 102,000

Step 2: Jars completed SAME WITH CONTINUOUS

during the period 79,200
Jars partially
completed in Ending WIP 15,000
Jars accounted for 94,200
SAME WITH CONTINUOUS
Jars accounted for
before any losses 94,200
Normal Spoilage 4,500
Abnormal Spoilage 3,300
Jars accounted for
after any losses 102,000
Step 3: DM DM CC
CC
BWIP units 12,000 12,000
BWIP units 12,000 12,000 S&C units 67,200 67,200
S&C units 67,200 67,200 EWIP units 15,000 11,250
 EWIP units 15,000 11,250 NL units 4,500 4,500
NL units - AL units 3,300 3,300
- EUP 102,000 98,250
AL units 3,300
3,300
EUP 97,500
93,750

Step 4: DM CC SAME WITH CONTINUOUS

BWIP, bal. 16,230 3,459
Current cost 101,745 19,041
Total Cost 117,975 22,500

Total cost for DM 117,975

Total Cost for CC 22,500
Total Cost to
Account for 140,475

Step 5: DM CC DM CC
Total Cost 117,975 22,500 Total Cost 117,975 22,500
Divide: EUP 97,500 93,750 Divide: EUP 102,000 98,250
Cost per EUP 1.21 0.24 Cost per EUP 1.16 0.23

Cost Assignment: Cost Assignment:

Step 6: Transferred out: EWIP:
DM: 79,200 x 1.21 = 95,832 DM: 15,000 x 1.16 = 17,400
CC: 79,200 x 0.24 = 19,008 114,840 CC: 11,250 x 0.23 = 2,587.5 19,987.5

EWIP: Abnormal Losses:

DM: 15,000 x 1.21 = 18,150 DM: 3,300 x 1.16 = 3,828
CC: 11,250 x 0.24 = 2,700 20,850 CC: 3,300 x 0.23 = 759 4,587

Abnormal Losses:
DM: 3,300 x 1.21 = 3,993
CC: 3,300 x 0.24 = 792 4,785
Total Cost Accounted for 140,475

Transferred out:
DM: 79,200 x 1.16 = 91,872
CC: 79,200 x 0.23 = 18,216
Cost of T-out
before NL 110,088
Absorption of NL:
DM: 4,500 x 1.16 = 5,220
CC: 4,500 x 0.23 = 1,035 116,343
Total Cost Accounted for
140,917.5

Inspection point : 50% completed

EWIP 75% completed
EIT VS IET
Cost allocated to NL 6,255
Normal Loss Allocation Cost after NL
Cost of EWIP prior to consideration of NL 19,987.5 961.15 20,948.65
Cost of T-out prior to consideration of NL 110,088 5,293.85 115,381.85
130,075.5 6,255 136,330.5

Sample Problem:
Copperfield Manufacturing employs a weighted average process costing system for its products.
One product passes through three departments (Molding, Assembly, and Finishing) during
production. The following activity took place in the Finishing Department during April 20x6.

Units in beginning inventory 4,200

Units transferred in from Assembly 42,000
Units spoiled 2,100
Good units transferred out 33,600
The costs per equivalent unit of production for each cost component are as follows:

Cost of prior departments Php 5.00

Raw material
1.00
Conversion
3.00
Total cost per EUP Php 9.00
Raw material is added at the beginning of the Finishing process without changing the number of units
being processed. Work in process inventory was 40 percent complete as to conversion on April 30.
All spoilage was discovered at final inspection. Of the total units spoiled, 1,680 were within normal
limits.

Requirements:
a. Calculate the equivalent units of production
b. Determine the cost of units transferred out of Finishing
c. Determine the cost of ending Work in Process Inventory

a. EUP schedule
T-in Mat CC
BWIP 4,200 4,200 4,200
S&C 29,400 29,400 29,400
EWIP 10,500 10,500 4,200
Normal Sp 1,680 1,680 1,680
Abnor Sp 420 420 420
46,200 46,200 39,900
b. Cost of units transferred out of Finishing
Cost of completed
units from BWIP 4,200 x 9 37,800
Cost of S&C units 29,400 x 9 264,600
Normal loss 1,680 x 9 15,120
PHP 317,520

c. Cost of ending Work in Process Inventory

Transferred in cost 10,500 x 5
Php52,500
Raw materials 10,500 x 1 10,500

Conversion Cost 4,200 x 3 12,600

Php75,600

T-out & EWIP 393,120

Abnormal Loss 3,780
TCTA 396,900