Calculate the Average Cost Method for Inventory - DOC

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```					                                      CHAPTER 17

PROCESS COSTING

I. LEARNING OBJECTIVES

1. Identify the situations in which process-costing systems are appropriate

2. Describe the five steps in process costing

3. Calculate equivalent units and understand how to use them

4. Prepare journal entries for process-costing systems

5. Use the weighted-average method of process costing

6. Use the first-in, first-out (FIFO) method of process costing

7. Incorporate standard costs into process-costing systems

8. Apply process-costing methods to situations with transferred-in costs

II. CHAPTER SYNOPSIS
Chapter 17 presents the topic of process costing. Process costing is at the other end of the
spectrum from job costing. Unlike job costing, a method used when producing small quantities
of very unique goods or services, process-costing systems are used when companies produce a
large quantity of identical or very similar goods or services. Whereas job-costing systems
typically cost each job using the actual quantity of resources consumed, process-costing systems
calculate an average cost per unit for all units produced.

Five steps to process costing:

Step 1.     Summarize the flow of physical units of output.
Step 2.     Compute output in terms of equivalent units.
Step 3.     Compute equivalent-unit costs.
Step 4.     Summarize total costs to account for.
Step 5.     Assign total costs to units completed and to ending work in process.

The weighted-average method and the first-in, first-out (FIFO) method are two common process-
costing methods. The primary difference between the two methods is that the FIFO method
segregates current period production costs and units from the production costs and units that are
part of beginning work in process. The chapter also discusses use of standard costs and process
costing with transferred-in costs.

17-1
III. CHAPTER OUTLINE

LEARNING OBJECTIVE #1:
Identify the situations in which process-costing systems are appropriate.

Process-costing systems are appropriate when companies produce a large quantity of identical or
very similar (homogeneous) goods or services. The close similarity of the units produced means
that the cost differences between units aren’t significant enough to justify a more complex and
costly product-costing system.

LEARNING OBJECTIVE #2:
Describe the five steps in process costing.

Accurate process costing requires analysis of product flow, calculation of equivalent units,
calculation and assignment of unit costs.
The five steps to process costing are:

Step 1      Summarize the flow of physical units of output.
Step 2      Compute output in terms of equivalent units.
Step 3      Compute equivalent-unit costs.
Step 4      Summarize total costs to account for.
Step 5      Assign total costs to units completed and to ending work in process.

(Exhibits 17-1 and 17-2 display the five steps in process costing.)

17-2
LEARNING OBJECTIVE #3:

Calculate equivalent units and understand how to use them.

Calculation of equivalent units requires separate determination of progress or completion of each
cost element or cost pool (direct materials, direct labor, manufacturing overhead). For example,
10,000 units that are 50% completed equals 5,000 equivalent units. Total costs for each cost
element divided by the equivalent units for that cost element equals the cost-per-equivalent-unit
for that cost element. That per-unit cost is then multiplied by the number of completed and work-
in-process units to determine the cost of goods manufactured and the ending work-in-process
inventory balances.

LEARNING OBJECTIVE #4:
Prepare journal entries for process-costing systems.

The journal entries in process costing for direct materials and conversion costs (direct labor and
manufacturing overhead) are very similar to the journal entries made in job-costing systems. The
major difference between the two costing systems is that job-costing systems have a single work-
in-process account for each job, while process-costing systems have a work-in-process account
for each processing department (manufacturing, electrical, painting, etc.). The cost of goods
completed (transferred out) for one department becomes the transferred-in costs for the next
department when the production process involves more than one department. Accounting for
transferred-in costs is discussed in more detail later in the chapter.

(Exhibit 17-3 diagrams the flow of costs in a process-costing system.)

Assign Exercises 17-16 PHGA, 17-17, and 17-18 PHGA.

17-3
LEARNING OBJECTIVE #5:
Use the weighted-average method of process costing.

The weighted-average method of process costing is the simplest process-costing method because
no distinction is made between the costs associated with beginning work-in-process inventory and
the costs incurred during the current period. The weighted-average method of process costing
calculates the cost per equivalent unit for each cost element or cost pool (direct materials, direct
labor, manufacturing overhead) as being equal to the total costs for that cost element or cost pool
divided by the total equivalent units for that cost element. Although the cost per equivalent unit
is calculated using total costs and total units for the cost element being analyzed, costs are still
assigned and tracked separately for ending work-in-process inventory and transferred-out units.

(Exhibits 17-4 and 17-5 display use of the weighted-average method for process costing.)

Do Chapter Quizzes #1, #2, and #3.                Assign Exercises 17-19 PHGA, 17-20 PHGA and
17-24;
Problems 17-30 and 17-31.

LEARNING OBJECTIVE #6:
Use the first-in, first-out (FIFO) method of process costing.

The first-in, first-out (FIFO) method calculates and separates per-unit cost based on the time
frame when the work was done. Whereas the weighted-average calculation of equivalent-unit
costs for work done in the current period is still total costs divided by total units, the FIFO
method calculates the cost of work done in the current period as costs added divided by units
added. The FIFO method also assumes that the units and costs in beginning work-in-process
inventory are the first units completed and transferred out in the current period. The weighted-
average method is the easier method to use, perhaps why it is also the most commonly used
process-costing method, but the first-in, first-out (FIFO) method provides managers with better
information about changes in costs from one period to the next.

(Exhibits 17-6 and 17-7 display use of the FIFO method for process costing.)

Do Chapter Quizzes #4, #5, and #6. Assign Exercises 17-21 PHGA, 17-22 PHGA and 17-25 and
Problem 17-32.

17-4
LEARNING OBJECTIVE #7:
Incorporate standard costs into a process-costing system.

The standard-costing method of process costing uses standard costs per equivalent unit as the
basis for costing and reporting the cost of completed and work-in-process units. Standard costing
uses the same five-step process as the weighted-average and FIFO methods, but assigns the costs
using the standard rates of direct materials and conversion costs instead of the actual rates.
Variances are calculated at the end of each period and journalized in a manner similar to the
variances discussed in earlier chapters.

(Exhibits 17-8 and 17-9 illustrate incorporation of standard costs into a process-costing
system.)
(Exhibit 17-10 displays the flow of standard costs in a process-costing system.)

Do Chapter Quizzes #7, #8, and #9.               Assign Exercises 17-23 and 17-26.

LEARNING OBJECTIVE #8:
Apply process-costing methods to cases with transferred-in costs.

Many companies have production processes involving more than one department. As units move
from one production department to the next production department, the costs associated with the
units are also transferred from one department to the next. These transferred-in costs (also
known as previous department costs) are treated similar to a direct-materials costs that is
completed as soon as the units are transferred in. The calculation of per-unit costs using both the
weighted-average and FIFO methods is identical to the previous examples, except that there is
now a new category of input costs (transferred-in costs) that is always 100% completed.

(Exhibits 17-11 and 17-12 display use of the weighted-average method with transferred-in
costs.)
(Exhibits 17-13 and 17-14 display use of the FIFO method with transferred-in costs.)

Do Chapter Quiz #10.             Assign Exercises 17-27 EXCEL and 17-28 EXCEL; Problems 17-33
and 17-34.

17-5
IV. CHAPTER 17 QUIZ
Use the following information for questions 1–10.
Top That manufactures baseball-style hats. Material is introduced at the beginning of the process
in the Cutting Department. Conversion costs are incurred (and allocated) uniformly throughout
the process. As the cutting of material is completed, the pieces are immediately transferred to the
Sewing Department. Data for the Cutting Department for the month of February 2005 follow:

Work in process, January 31 — 50,000 units
100% complete for direct materials, 40% completed for conversion costs
actual costs of direct materials, \$70,500; actual costs of conversion, \$34,050

Units started during February,      225,000
Units completed during February, 200,000
Work in process, February 28 — 75,000 units
100% complete for direct materials, 20% completed for conversion costs
Direct materials added during February [actual costs]      \$342,000
Conversion costs added during February [actual costs]      \$352,950

1. Assuming Top That uses the weighted-average method to account for inventories, the
equivalent units of work for the month of February are
Direct Materials         Conversion Costs
a.      225,000                  225,000
b.      200,000                  200,000
c.      275,000                  215,000
d.      225,000                  200,000

2. Assuming Top That used the weighted-average method to account for inventories, the cost
per equivalent whole unit produced during February is
a. \$3.30.           b. \$3.55.              c. \$3.77.             d. \$4.00.

3. Assuming Top That uses the weighted-average method to account for inventories, the
assignment of costs to work in process at the end of February is
a. \$300,000.        b. \$266,250.             c. \$166,525.        d. \$139,500.

4. If Top That uses the first-in, first-out (FIFO) method to account for inventories, the
equivalent units of work for the month of February are
Direct Materials           Conversion Costs
a.      225,000                     225,000
b.      225,000                     195,000
c.      275,000                     200,000
d.      200,000                     195,000

5. If Top That uses the FIFO method to account for inventories, the costs per equivalent unit for
February are
Direct Materials       Conversion Costs
a.      \$1.50                  \$1.76
b.      \$1.83                  \$1.72
c.      \$1.71                  \$1.81
d.      \$1.52                  \$1.81

17-6
6. Assuming Top That uses the first-in, first-out (FIFO) method to account for inventories, the
assignment of costs to units completed and transferred to the Sewing Department during
February is
a. \$658,350.        b. \$636,450.              c. \$666,000.           d. \$652,000.

The following additional data apply to questions 7–9.
Standard costs for the Cutting Department: Direct materials - \$1.50 per unit; Conversion costs -
\$1.75 per unit
7. The standard costs of units completed and transferred from the Cutting Department during
February is
a. \$731,250.        b. \$650,000.             c. \$678,750.            d. \$600,000.
8. The conversion costs variance for the month of February is
a. \$40,800 favorable.                               c. \$11,700 unfavorable.
b. \$94,250 favorable.                               d. \$29,750 unfavorable.
9. The journal entry to record inventory costs and direct-material variances for the month of
February is
a. Cutting Department Control                         342,000
Direct Material Variances                                        4,500
Work in Process—Cutting Department                        337,500
b. Work in Process—Cutting Department                337,500
Direct Material Variances                           4,500
Cutting Department Control                                    342,000
c. Work in Process—Cutting Department                342,000
Direct Material Variances                                        4,500
Cutting Department Control                                     337,500
d. Work in Process—Cutting Department                341,250
Direct Material Variances                             750
Cutting Department Control                                    342,000
10. In the Sewing Department, additional direct materials are added to the product at the end of
production. Without prejudice to your answer for questions 1– 9, assume that 200,000 units
were transferred from the Cutting Department and that the weighted-average method is used.
Data for February follow:

Work in process, January 31 — 70,000 units (30% complete as to conversion)
Units completed during February - 240,000 units
Work in process, February 28 — 30,000 units (80% complete as to conversion)
For the Sewing Department, the equivalent units of work done in February is
Transferred In       Direct Materials         Conversion Costs
a.      200,000                200,000                 200,000
b.      200,000                170,000                 194,000
c.      240,000                240,000                 245,000
d.      270,000                240,000                 264,000

17-7
CHAPTER 17 QUIZ SOLUTIONS:
1. C 2. A 3. D 4. B 5. D 6. A 7. B        8. C 9. B   10. D

Clements, R. and Spoede, C., ―Trane’s SOUP Accounting,‖ Management Accounting (June 1992)
p.46 [7p].

Longmore, P., ―Process Costing Demystified,‖ Accountancy (October 1994) p.88 [3p].

17-8

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