Review

Questions for discussion

Management Accounting 2A
Direct and Absorption
Self-assessment 4 Question 1
Costing
COMAA2-22
Throughput
Self-assessment 4 Question 2
Accounting

Throughput accounting,
Digital costing systems and Practice Quiz 8.2: Questions ?
Digital products
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Week 4: Lesson 10 : Process costing What will be covered

in today’s lesson?
Learning outcomes
Understanding process
costing and equivalent units
In this lesson, you will learn how to:
• Describe the basic characteristics and nature of a process costing system. Lesson 10 Understanding spoilage point
and losses : Applying the
• Construct a process costing report for a single product using a single process or
Process costing principles of FIFO and WACO
multiple processes.
Preparation of Production or
• Calculate equivalent completed units. Quantity Statements

• Compile process cost reports if inventory is valued at weighted average method

Preparation of the Cost
as well as the FIFO method. Statement

• Compile process cost reports if wastage (normal and abnormal) occurred during Preparation of the Allocation
Statement
the process.

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 What is process costing? Job versus process costing
It is an accounting system used for products produced on a continuous basis
Job costing Process costing
according to standard specifications. It applies to products that are:
Cost accumulation point The product The process
• Identical (homogeneous) products (each unit contains the same quantity of
Types of products Heterogeneous products Homogeneous products
material, labour, and manufacturing overheads).
manufactured
• Produced in large quantities
• Costs are collected for a fixed period Type of industry in which the Building industry Food industry
costing system can be found Civil engineering Canning factory
Examples: Food such as canned food, and petrol, paint, soft drinks, or steel.
Specific costing systems Job and contract costing Process costing
resorting under each group
Due to the similarity of the products, it is not required to trace manufacturing costs
through to each individual product: the total cost incurred during a period is simply
divided by the units produced to obtain a cost per unit. Source: Fundamentals of cost and management accounting

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Allocation of costs Equivalent completed units

• The concept of equivalent completed units (ECU) requires that units that are
partially completed, be converted into their equivalent number of completed
units. These ‘completed’ number of units are then used in the process costing
calculation.
• Incomplete units are expressed in terms of the quantity that would be equal to
completed units based on the material, labour and overheads used in these units.

+ =

• Concept: 2 x half = 1 full (equivalent completed unit)

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 Equivalent units Example 1
A company using process costing may not start every month with no work-in-progress During April, ABC Ltd produced 50 completed units of a product, and incurred total
(WIP), or finish with no WIP – therefore, not all units ‘worked’ on during a month will be production costs of R100 000. What is the closing inventory value of each unit?
started and completed in the same period. The opening and closing WIP may also be
at different stages of completion. Solution

However, it would be unreasonable for the company not to allocate some costs to units
that are already in the production process, as those units would already have
consumed resources (like material and labour).

Thus, we use equivalent units as an idea of how much the WIP is ‘worth’ based on the
costs it has incurred thus far (to be able to show a reasonable value for these items on
the statement of financial position, and to allocate the production costs fairly). The
allocation statement allows us to allocate the production costs appropriately, taking
into account both (i) the stage of completion and (ii) the inventory valuation technique
(FIFO or weighted average) used to account for costs.

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Example 2 Example 3
During May, XYZ Ltd produced 70 completed units, and a further 50 units that were at At the start of July, DEF Ltd had 30 units of WIP with a total value of R12 000 at a 40%
a 30% stage of completion. ABC’s total production costs for May were R97 750. What stage of completion. DEF incurred a further R114 130 during July to produce (in total)
is the value of each unit if ABC makes use of a FIFO inventory system? 90 completed units of its product as well as 50 incomplete units that were at a 70%
stage of production. What is the value of each unit in a FIFO environment?
Solution
Solution

FIFO, thus first COMPLETE the opening WIP:

There are 30 units at 40% stage of completion.

Need to ADD 60% work to finish them in this month.
Thus, DEF worked on (30 x 60%) = 18 units.

In total, DEF completed 90 units. The first 30 of these would have been from opening
inventory. Therefore, DEF also started (from scratch) and completed 60 units in July.
(These 60 units went from 0 to 100% in July.)

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 Example 3 solution (continued) Example 4
DEF also worked on 50 units that are not quite finished by month’s end: At the start of July, ABC Ltd had 30 units of WIP with a total value of R12 000 at a 40%
They’re at a 70% stage of completion. stage of completion. During July, ABC Ltd completed 90 units of its product, and also
Thus, DEF worked on (50 x 70%) = 35 units. worked on the manufacturing of a further 50 units that could not be completed by
month’s end – these 50 units were at a 70% stage of production. ABC Ltd incurred
Altogether therefore, DEF worked on: 18 + 60 + 35 = 113 units manufacturing cost of R114 130 during July. ABC Ltd uses a weighted average costing
system. What is the value of each unit of inventory on 31 July?
R114 130 / 113 = R1 010 per equivalent unit
Solution
Value of finished goods = R1 010 per unit

Value of WIP (closing) = (R1 010 x 35) / 50 = R707 per unit

Opening stock completed (now finished goods):

= (R12 000 cost carried forward from June + R1 010 x 18 equivalent work in July)
= R30 180 / 30 unit completed
= R1 006 value for each completed unit that started as opening WIP.

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Example 4 solution (continued) The above examples considered total cost without distinguishing between material
and conversion costs. However, these costs are not always incurred at the same time.
Often, material is added at the start of the production process, and labour and
overheads are incurred continuously and evenly over a specified period of time (e.g. a
month or a year).

Example 5: ABC added 20 000 units to a process where all the material is added at
the beginning of the process while labour and overheads are used continuously and
evenly throughout the process. No units were completed during the current accounting
period. Instead, all units are physically 70% complete at the end of the period.

Equivalent completed units

Calculation of equivalent production: Direct material Conversion costs
Closing WIP: 20 000 units
- 20 000 x 100% 20 000
- 20 000 x 70% 14 000

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 Example 6: Separating material and conversion costs Solution - FIFO
At the start of July, PQR Ltd had 30 units of WIP with a total value of R12 000 at a 40% Inventory (units) Units Material Labour Overheads
stage of completion. The R12 000 consisted of R6 000 for material, R4 000 for labour, Finished goods 90 60 78 78
and R2 000 for overhead costs allocated to the products. PQR incurred the following
- O/WIP 30 - 18 18
additional manufacturing costs during July:
- This month 60 60 60 60
• Material: R23 100 Closing WIP 50 50 35 35
• Labour: R38 420 140 110 113 113
• Overheads: R19 210
Note the following:
Material is added at the start of the production process, and labour and overheads are • Only include what is required to complete the opening WIP. The material was
incurred evenly throughout the production process. PQR completed (in total) 90 units added in June, and is therefore not included here again. Only 60% needs to be
during July, as well as 50 incomplete units that were at a 70% stage of production. added with respect to the conversion costs to complete the units.
• The units started and completed this month carry a 100% weighting in every cost
Required: Determine the value of each type of inventory if column.
(1) FIFO is applied as the inventory valuation technique; • The closing WIP also shows what was incurred this month – all the material for
(2) Weighted average is applied as the inventory valuation technique. the closing WIP was added this month, but only 70% of the conversion cost.

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Cost Total Material Labour Overheads Cost allocation

R R R R
Units started and completed: 60 units x R(210 + 340 + 170)
O/WIP 12 000 - - - = 60 units x R720 per unit
Added in July 80 730 23 100 38 420 19 210 = R43 200
Total cost 92 730 23 100 38 420 19 210
Closing WIP: (50 units x R210) + (35 units x R[340 + 170])
Note that the cost of the opening WIP is NOT added to the costs that will be allocated = R10 500 + R17 850
to all the units – in FIFO, the cost for the opening WIP is not ‘mixed’ with the cost of = R28 350
the current production. (on average) = R28 350 / 50 units
= R567 per unit
Cost per unit Material Labour Overheads
Total costs R23 100 R38 420 R19 210 Opening WIP (now finished): (18 units x R[340 + 170]) + R12 000
= R9 180 + R12 000 R43 200
Divided by: Equivalent units 110 units 113 units 113 units = R21 180 R28 350
Cost per unit R210 p.u. R340 p.u. R170 p.u. (on average) = R21 180 / 30 units R21 180
= R706 per unit R92 730

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 Solution – Weighted average Cost per unit Material Labour Overheads
Inventory (units) Units Material Labour Overheads

Cost allocation

Cost Total Material Labour Overheads

R R R R

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Losses – Normal losses Normal losses (continued)

Losses or wastage can occur at any of the following stages in the production process: The cost of normal losses must be absorbed by all inventory items in the production
• at the beginning of the process process that moved past the inspection point in the current period. Consider work-in-
• at any point during the process progress especially.
• at the end of the process

Normal losses |________________|___________|________________|__________|

These are losses that are inevitable in (inherent to) the production process, for 0% 20% 50% 75% 100%
example the evaporation of liquids. Normal losses are: Material added O/WIP Spoilage point C/WIP Complete
• Part of the product costs as
• These losses are uncontrollable: they cannot be avoided or eliminated.
In the example above, both the opening WIP (O/WIP) and the closing WIP (C/WIP) will
Please note that: move past the spoilage point during this month. Consequently, ALL inventory items will
• The number of units produced (or expected to be produced) become less, but share in the cost of the normal loss, and the “short” allocation method can be used
• The the cost in total stays the same, thus (example will be given below).
• The cost per unit increases.

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 Normal losses (continued)
|________________|______________|________________|__________|
0% 20% 50% 75% 100%
Material added Spoilage point O/WIP C/WIP Complete |________________|______________|________________|__________|
0% 20% 50% 75% 100%
Material added C/WIP Spoilage point O/WIP Complete
In the example above, the opening WIP (O/WIP) will not move past the spoilage point
in the current month. It would have done so in the previous month already. The closing
WIP (C/WIP) will move past the spoilage point during this month. The “short” allocation
method cannot be used if FIFO is used, and the cost of the normal spoilage should In the example above, neither the opening nor the closing work-in-progress will move
only be allocated proportionately to (i) C/WIP and (ii) units started and completed in past the spoilage point in the current month. The cost of the normal loss should only
this month (and (iii) to abnormal losses, if any occurred in this month, and at the same be allocated to the units started and completed in this month.
spoilage point). If the weighted average method is used, the short method can still be
used as no distinction is made between O/WIP and units started and completed.

Note that the cost of the normal loss is allocated to the different inventory items on
physical units, not equivalent units!

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Example 7 Example 7(1) solution

Company ABC started 10 000 units of their product during July. There was no opening Production statement
work-in-progress. Material cost for the month was R50 000. Company ABC completed Total Material Conversion
7 000 units in July, and also have WIP of 2 000 units on hand at the end of the month,
that is 60% complete. To work on all of these units (complete and incomplete), labour Completed 7 000 7 000 7 000
and overhead cost of R36 800 was incurred during July. 1 000 units were lost during WIP 2 000 2 000 (60%) 1 200
the month at the 50% inspection point, which is in accordance with the company’s Normal loss 1 000 1 000 (50%) 500
expectations. 10 000 10 000 8 700

Required Cost statement

Prepare a process cost report, using:
Total Material Conversion
(1) The long allocation method; and Current cost 86 800 50 000 36 800
(2) The short allocation method if it is appropriate to do so. ÷ Equivalent products ÷ 10 000 ÷ 8 700
Cost per unit 5.00 4.23

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 Example 7(1) solution (continued) Example 7(2) solution The short method can be used as all the inventory
Production statement items passed the spoilage point in this month.
Cost of the normal loss:
(1 000 x R5.00) + (500 x R4.23) = R7 114.94 Total Material Conversion
Allocation statement
Completed 7 000 7 000 7 000
WIP 2 000 2 000 (60%) 1 200
Completed units:
Normal loss 1 000 - (50%) -
7 000 x R9.23 = R64 609.20
10 000 9 000 8 200
PLUS!
7 000 / 9 000 x R7 114.94 = R 5 533.84 Cost statement
R70 143.04
Closing WIP: Total Material Conversion
2 000 x R5.00 + 1 200 x R4.23 = R15 075.86 Current cost 86 800 50 000 36 800
PLUS! Total allocated:
÷ Equivalent products ÷ 9 000 ÷ 8 200
= R70 143 + R16 657
2 000 / 9 000 x R7 114.94 = R 1 581.10 Cost per unit 5.56 4.49
R16 656.96 = R86 800

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Example 7(2) solution (continued) Losses – Abnormal losses

Allocation statement Abnormal losses are losses that are not expected to occur under efficient operating
conditions, due to e.g. the use of inferior materials, improper mixing of ingredients,
Completed units: 7 000 x R10.04 = R70 303.52 accidents, meltdowns, load-shedding interruptions, etc. These are losses exceeding
the expected normal loss (actual output < expected output).
Closing WIP:
2 000 x R5.56 + 1 200 x R4.49 = R16 496.48 AL = Total input (units) - Completed & transferred - Normal losses - Closing WIP.
R86 800.00
Abnormal losses are period costs as these losses are controllable and can (and
should) be eliminated.

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 Calculating the losses Example 9
Example 8 Company ABC put 2 000 units into production this month, completed 1 400 units and
Company ABC put 2 000 units into production this month, completed 1 400 units and had closing WIP of 300 units, which were at 60% in terms of conversion costs.
had closing WIP of 300 units, which were at 60% in terms of conversion costs. Materials are added at the start of the process. The spoilage point, where a normal
Materials are added at the start of the process. The spoilage point, where a normal spoilage of 10% of input is expected, is at the 70% mark in the production process.
spoilage of 10% of input is expected, is at the 50% mark in the production process.
Required
Required Calculate the normal and abnormal losses that occurred this month.
Calculate the normal and abnormal losses that occurred this month.
Solution
Solution
The closing WIP moved past the inspection point in this month, therefore all inventory
items were subject to spoilage:

Normal loss = 2 000 units x 10% = 200 items

Abnormal loss = 2 000 – 1 400 – 300 – 200 = 100 items

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Example 10 Example 11
Company ABC started the month with opening inventory of 150 units, which were 40% Company ABC started the month with opening inventory of 150 units, which were 60%
complete in terms of conversion costs, and put a further 1 850 units into production complete in terms of conversion costs, and put a further 1 850 units into production
this month. ABC completed 1 400 units and had closing WIP of 300 units, which were this month. ABC completed 1 400 units and had closing WIP of 300 units, which were
at 60% in terms of conversion costs. Materials are added at the start of the process. at 30% in terms of conversion costs. Materials are added at the start of the process.
The spoilage point, where a normal spoilage of 10% of input is expected, is at the 50% The spoilage point, where a normal spoilage of 10% of input is expected, is at the 50%
mark in the production process. mark in the production process.

Required Required
Calculate the normal and abnormal losses that occurred this month. Calculate the normal and abnormal losses that occurred this month.

Solution Solution

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 Process costing reports Production statement
1. The production statement: This shows what happened to the units and is used to
calculate equivalent units.
• The statement therefore shows how many units were received in the department - Opening WIP
or started during the period under review, and where these units went, i.e. to Input units - Added in this period
finished goods, work-in-progress, or losses.
• The statement is expressed in terms of quantity, not Rand.
• The stages of completion are taken into account in determining the ’equivalent
Production
number of units’ for each cost element (e.g. material, labour, and overhead). statement
2. The production cost statement: This is used to collate the total cost for material, - Completed & transferred
labour, and overhead, respectively, and to calculate the cost per equivalent unit. - Normal losses
Output units - Abnormal losses
3. The allocation statement: This is used to allocate the costs to the output as - Closing WIP
determined in the production statement.

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Production statement Production cost statement

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 Allocation statements Example 12
Company ABC started 10 000 units of their product during July. Material cost for the
month was R50 000. Material is added at the start of the process.

ABC completed 7 000 units in July, and also had closing WIP of 2 000 units on hand,
that were 40% complete. To work on all of these units, labour and overhead costs of
R35 275 were incurred during July. Normal and abnormal losses are identified at the
50% inspection point, and normal losses, calculated on actual input, are expected to
be 10%.

ABC makes use of a FIFO inventory valuation system.

Required
Prepare a process cost report.

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Solution Normal loss = (10 000 – 2 000) x 10% = 800 units Example 12 solution (continued)
Quantity statement Abnormal loss = 10 000 – 7 000 – 2 000 – 800 = 200 units
Cost of the normal loss:
(800 x R5.00) + (400 x R4.25) = R5 700.00
Total Material Conversion
Completed 7 000 7 000 7 000 Allocation statement
WIP 2 000 2 000 (40%) 800 Completed units: 7 000 x R9.25 = R64 750.00
Normal loss 800 800 (50%) 400 PLUS!
Abnormal loss 200 200 (50%) 100 7 000 / 7 200 x R5 700.00 = R 5 541.67
10 000 10 000 8 300 R70 291.67
Abnormal loss:
Cost statement 200 x R5.00 + 100 x R4.25 = R 1 425.00
Total cost allocated:
PLUS!
Total Material Conversion
200 / 7 200 x R5 700.00 = R 158.33
Current cost 85 275 50 000 35 275 70 291.67
R 1 583.33
÷ Equivalent products ÷ 10 000 ÷ 8 300 1 583.33
Closing WIP: 13 400.00
Cost per unit 5.00 4.25 2 000 x R5.00 + 800 x R4.25 = R13 400.00 85 275.00

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 Example 13 Solution
Company ABC started 9 500 units of their product during July. Material cost for the
month was R458 850. Material is added at the start of the process.

ABC also had 500 units in opening WIP at the start of July, which were 20% complete,
and which had accumulated the following costs: material of R24 000, and conversion
costs of R4 000.

ABC completed 7 000 units in July, and had closing WIP of 2 000 units on hand, which
were 60% complete. Conversion costs of R352 944 were incurred during July. Normal
and abnormal losses are identified at the 50% inspection point, and normal losses,
calculated on actual input, are expected to be 8%.

ABC makes use of a FIFO inventory valuation system.

Required
Prepare a process cost report.

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Solution Example 13 solution (continued)

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 Class activity Solution – Weigted average

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Solution Solution

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 Solution – FIFO Solution
Normal loss = (16 000 + 174 000) x 10% = 19 000 units The opening inventory costs are NOT added to the current month’s cost.
Abnormal loss = 190 000 – 151 000 – 15 000 – 19 000 = 5 000 units

Cost statement Total Material Labour Overheads

Quantity statement Total Material Labour Overheads
Opening inventory 167 040 - - -
Completed 151 000 136 600 147 400 147 400
Current cost 2 490 210 1 107 510 886 000 496 700
Opening WIP (- loss %) 14 400 - (75%) 10 800 10 800
Total cost 2 657 250 1 107 510 886 000 496 700
Started and completed 136 600 136 600 136 600 136 600
÷ Equivalent products ÷ 156 600 ÷ 158 400 ÷ 158 400
Closing WIP 15 000 15 000 (60%) 9 000 9 000
Cost per unit 7.07 5.59 3.14
Normal loss (short method) 19 000 - - -
Abnormal loss 5 000 5 000 (40%) 2 000 2 000
Total 190 000 156 600 158 400 158 400

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Solution Further activities

Allocation statement R
Refer to the activities in the process costing handout.
Finished goods
- Opening inventory 261 315
Previous month 167 040
Current month 10 800 units x R(5.59 + 3.14) 94 275
- Started and completed 136 600 x R(7.07 + 5.59 + 3.14) 2 158 470
2 419 785

Closing WIP (15 000 x R7.07) + (9 000 x R8.73) 184 646

Abnormal loss (5 000 x R7.07) + (2 000 x R8.73) 52 819
2 657 250

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 What Happens Next?
To be completed before the next Lecture-led session (self-directed learning
and assessments):
• Lesson 10 Practice Activities
• Self-assessment 5
• Week 4’s Learning Outcomes Post-assessment
• Lesson 11 (Joint and by product costing) Notes

What will be covered in the next Lecturer-led session:

• Joint and by product costing

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