In this presentation, we will review process costing systems. Costs related to the manufacturing of the actual product are combined in work-in-process accounts as debit entries to the accounts.
In a process costing system, costs are accumulated in processing departments. Each process department has a corresponding work-in-process account. For example, an automaker would most likely have at least a work-in-process account for the production department and another work-in-process account for the finishing department.
Costs to be accounted for in each processing department consist of the cost of the beginning inventory in the department plus costs of units transferring in from a preceding department, if any, plus costs added in the production department itself.
As the product is completed, we credit work-in-progress in debit finished goods. The product is now ready to sell.
As the products are sold, we credit finished goods and debit costs of goods sold.
In process costing, each unit is assigned the average cost of units processed through the department.
In order to compute the average cost per unit in a department, we first must know the total cost to account for and the total number of units processed.
Partially completed units are converted to equivalent whole units. For example, 200 units in ending inventory are 25 percent complete with respect to conversion costs is the same as 50 equivalent completed units.
The two common methods of computing average costs per unit are the weighted average method and the FIFO method.
Let’s review the weighted average method next.
The weighted average method averages together the beginning work-in-progress inventories with the units started during the current period.
For each category of cost in each processing department, the following the calculations are made.
First, we need to calculate the equivalent units of production. All units that were transferred out during the accounting period are considered 100 percent complete. However, units in ending inventory are generally partially completed. For example, units in ending inventory may be 100 percent completed for materials, but only 50 percent completed for conversion costs. Equivalent units of production are calculated by adding the total units transferred out and the equivalent units in ending inventory.
Once we have calculated the equivalent units of production, we need to determine the cost per equivalent unit. We take the costs in beginning inventory plus any costs added to the department during the accounting period and divide this total by the equivalent units of production previously calculated.
Next, we calculate the costs of the units transferred out. We simply multiply the cost per equivalent unit by the total units transferred out.
And, lastly, we calculate the cost of the units remaining in ending inventory by multiplying the cost per equivalent unit by the equivalent units in ending inventory.
Let’s work through an example.
The Hausing Company makes small sailboats. During the most recent month, the following activity was recorded in the hull fabrication department for conversion costs. Fifteen thousand units were 80 percent in beginning inventory. One hundred and eighty thousand units were started in the fabrication department and one hundred and seventyfive thousand units were transferred to the next department.
At the end of the period, ending inventory was comprised of 20,000 units, 30 percent completed, per conversion costs.
The costs associated with the fabrication department at the Hausing Company for the same accounting period were $24,000.00 for the units in beginning inventory and $338,000.00 added conversion costs during the month.
The first step is to calculate the equivalent units of production. We account for all units transferred out plus the equivalent units in ending inventory.
In this case, there were 20,000 units in ending inventory, 30 percent completed, therefore, the ending inventory equivalent units equals 6,000. Adding the equivalent units in ending inventory and the units transferred out we have 181,000 equivalent units of production during the month.
The next step is to calculate the cost per equivalent unit. We simply add the conversion costs in beginning inventory and costs adding during the month and we divide by the equivalent units of production previously calculated.
The above computations would be repeated for each classification of costs incurred in the production of sailboats.
The third step is to calculate the cost of units transferred out. Since we determined that the total units transferred out were 175,000 units, we multiply these units by the cost per equivalent unit for a total of 350,000 cost of units transferred out.
Lastly, we calculate the cost of units in ending inventory by multiplying the equivalent units in ending inventory by the cost per equivalent unit for a total of $12,000.
Note, the above computations would be repeated for each classification of costs incurred in the production of the sailboats.
The First In, First Out method separates the costs of beginning inventory from the costs incurred during the current period while the weighted average method combines them.
The First In, First Out method further assumes that the beginning inventory is completed before any new units are started.
Continuing with our example related to the Hausing Company and the activity that was recorded in the hole fabrication department for conversion costs during the most recent month, let’s take a look at the calculations for the First In, First Out method.
The first step is to calculate the equivalent units produced. Using the First In, First Out method, we assume that we must first complete the units in beginning inventory before we complete any other units, therefore, since we had 15,000 units completed 80 percent, we know that we must complete these units 20 percent.
In our example, to complete 15,000 units at 20 percent, equates 3,000 equivalent units. Then, during the month, we started 180,000 units that, since we have 20,000 units in ending inventory, we must have finished only 160,000 units, 180,000 minus 20,000, and the 20,000 units in ending inventory, since they were 30 percent completed per conversion cost, these units equate to 6,000 equivalent units. Adding these units together, the equivalent units to complete the beginning inventory, the units completed during the period, and the equivalent units in ending inventory, we come up with a total of 169,000 equivalent units of production.
The next step is to determine the cost per equivalent unit of production for conversion costs. We simply take the cost adding during the period and divide the equivalent units previously calculated.
The next step is to calculate the cost of the equivalent units remaining in ending inventory.
Earlier, we calculated that ending inventory was comprised of 6,000 equivalent units. We take these equivalent units and multiply by the costs per equivalent unit.
Lastly, we calculate the total costs of units transferred out. First, we need to calculate the cost to complete the equivalent units that we had in beginning inventory. We determine these to be 3,000 units, and we multiply by the cost per equivalent unit, 3,000 units multiplied by $2.00 equals $6,000.00.
Next, we determine that the units completed during the period were 160,000, therefore, we take those completed units and multiply by the cost per equivalent unit, 160,000 units multiplied by $2.00 equals $320,000.00.
Last, we add all of the costs together, including the costs that we originally had in our beginning inventory, $24,000.00 plus $6,000.00 plus $320,000.00 equals $350,000.00.
Note that the costs of ending inventory and of the units transferred to the next department are the same in this example under the weighted average and FIFO methods. However, this will not be true in those cases.
See above. Read the question in black. Give three possible answers for each question with the correct one being one of them.
This concludes this tutorial. You may want to print this information for future reference.
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